Despite that there may be many obvious reasons for any two companies to combine, most private-private mergers (where both companies are private entities) never come to fruition. Public-public, and public-private are actually much easier to consummate. There are many reasons why private-private is so difficult, but allow me to highlight three specific challenges that seem quite prevalent.

 1)    Structural Challenges

Private companies typically have capitalization structures that are very complex. There are common stock, common options, and as many as three to five different layers of preferred stock, each with a specific liquidation preference. Finding a way to meld two complex capital structures is non-trivial, and may require compromise from many parties involved. But institutional investors are loath to give up previously negotiated rights, and this can be especially true when the investor in a competitive company is the one bringing the request. Even melding two separate option programs can be challenging. There are numerous techniques for bringing together two such structures, but none of them are remotely elegant, and they all involve spending many, many hours with lawyers. At the end of the day, structure is not a show stopper, but it creates a very high bar for consideration – you have to really want to make it happen to be able to sit down and sort through the complexity.

 2)    People Challenges

Prior to a merger, you have two separate management teams (with two separate cultures), and in order to merge, you have to agree on who is going to do what, and what each executive’s new title will be. It should come as no surprise that executives are fairly sensitive when it comes to topics of reporting structure and titles. Plus, you have the natural tendency to view any discussion as an “us versus them” type argument, which is not a frame of mind that is conducive to collaboration. The bottom line is that it is very hard to merge two management teams, especially when you consider the contracted time window typically associated with such a discussion. It’s speed dating. As a result, only if you have two teams with a shared vision for the future, and minds that are open to compromise could you ever hope to be successful. Some pretty high-profile mergers have fallen apart because of this issue.

3)    Investor/Founder Mindset Challenges

Most founders and investors typically think about their personal stakes in a private company in terms of “ownership percentage.” An investor may say “we own 22% of the company”, or a founder may note, “I still own 31% of my company.” These same constituents think about the overall company value in terms of dollars. As an example you might hear someone say, “we closed the last round at $100 million post.” When two private companies began discussions on merging, these overall corporate values are often debated. I call this the “dueling blowfish” problem. Private company valuation techniques are particularly specious (this contrasts with a public company that every day has a definitive market capitalization). Anyone can create any number they want (within reason), as there is no one specific formula or metric for such work. Most models are also based on forward forecasts, which offers another avenue for inflation. Basically, everyone uses loose finance arguments to over-inflate their own company’s valuation so that they can demand a bigger slice of the pie of the new company.

The only way around this is to reverse your way of thinking. First, you have to focus on the dollar value of your new stake in the combined company instead of focusing on the specific percentage. Even in a 50/50 scenario, each ownership stake is half what it once was. Assuming the deal is accretive, this should be “no-brainer” math; your new stock in the combined company is worth more than it was before. However, the “ownership” focused mind has a real problem with their stake being reduced so dramatically. Second, you need to only negotiate in terms of percentages (versus dollar value). One company will get X% of the combined company, and one company will get 1-X%. Taking this approach is the only way around the dueling blowfish problem. Assuming both sides think the merger is a good idea (and accretive) the future value is obviously going to be higher. The real question is how do we split the company amongst the two players, and focusing on this out of the gate will save an incredible amount of time.

These are just the challenges that you meet on the way to the altar. Many mergers fail not in the deal process but in the implementation process, as integration is very difficult, especially when it’s a merger of equals. And the human and cultural issues outlined above continue to exist as you attempt to merge two companies into one. Getting the “deal done” is only the beginning.

Once again, I am quite excited about the Grubhub/Seamless merger, and tip my hat to Matt Maloney, Mike Evans, Jonathan Zabusky, and both the Grubhub and Seamless management teams. Had they not started from day one of our discussions with a partnership mindset, we would have never have reached this milestone. I look forward to working with them both, as well as the investors and independent directors from both sides to help take the merged company to new heights.

Many Internet marketplaces also have a rake or vig. The percentage rake is the amount that the marketplace charges as a percentage of GMS (gross merchandise sales), which typically represents net revenues for the marketplace. As an example, eBay’s 2011 marketplace revenues were approximately $6.6B against GMS of approximately $68.6B for a rake percentage of just under 10%. It may seem tautological that a higher rake is always better – that charging more would be better than charging less. But in fact, the opposite may often be true. The most dangerous strategy for any platform company is to price too high – to charge a greedy and overzealous rake that could serve to undermine the whole point of having a platform in the first place.

Before discussing the merits of low rakes versus high rakes, let us first take a look at current examples of different rakes across the Internet. The table above shows estimated rakes for several online businesses as a percentage of GMS. Do not assume that these numbers are specifically accurate as some vendors make these very hard to deduce.*  There is also the added noise of kick-backs that are common in industries like ticketing. You can see very high rakes in the case of iTunes, Facebook, and GroupOn down to especially low rakes for the likes of OpenTable and HomeAway. Amazon marketplace fees are published on their website, and vary by category, but they basically range from 6-15%, so lets say the average is approximately 12%. eBay recently launched an aggressive campaign attacking Amazon’s rate table on a vertical-by-vertical basis (those percentages can be found here). One company with an astonishingly high rake is recently IPOed Shutterstock, a photo-purchasing marketplace where the content owner receives only 30% of gross receipts. As we will argue below, this could in fact be a very fragile situation.

When evaluating new marketplace investments, we are naturally biased towards entrepreneurs who understand the strategic rationale behind the argument for a lower rake. If your objective is to build a winner-take-all marketplace over a very long term, you want to build a platform that has the least amount of friction (both product and pricing). High rakes are a form of friction precisely because your rake becomes part of the landed price for the consumer. If you charge an excessive rake, the pricing of items in your marketplace are now unnaturally high (relative to anything outside your marketplace). In order for your platform to be the “definitive” place to transact, you want industry leading pricing – which is impossible if your rake is the de facto cause of excessive pricing. High rakes also create a natural impetus for suppliers to look elsewhere, which endangers sustainability. These reasons are likely behind the struggles in GroupOn’s core Daily Deals business (North America Third Party Revenue is down in Q4 both YOY and QOQ). With a rake of approximately 38% (and this is “after” asking the merchant to underwrite a 50% discount to the consumer) the recovery from each transaction for the supplier is only 30%, representing an “effective” rake of 70%.

High volume combined with a modest rake is the perfect formula for a true organic marketplace and a sustainable competitive advantage. A sustainable platform or marketplace is one where the value of being in the network clearly outshines the transactional costs charged for being in the network. This way, suppliers will feel obliged to stay on the platform, and consumers will not see prices that are overly burdened by the network provider. Everyone wins in this scenario, but particularly the platform provider. A high rake will allow you to achieve larger revenues faster, but it will eventually represent a strategic red flag – a pricing umbrella that can be exploited by others in the ecosystem, perhaps by someone with a more disruptive business model. As Jeff Bezos is fond of saying, “your margin is my opportunity.”

Many people do not know this, but one of the most amazing Internet success stories is the European division of The Priceline Group, which operates under the brand Booking.com. Booking.com is the unquestioned leader in online travel in Europe, and represents a substantial portion of TPG’s astounding $35B market capitalization. Booking.com was not always the online leader in Europe – in fact they were a disrupter stealing the flag from other large incumbents. In the late 1990’s companies like Expedia and Travelocity had become enamored with what is known as the “merchant model.” Basically, these companies would “package” vacation offerings for the consumer and sell them as a bundled offering. The merchant model could produce a rake of well over 30%, and was therefore attractive to companies like Expedia. Booking.com took a much more aggressive approach (perhaps because it was the only one available) . They started with a 10% “agency model,” which not only represented a lower rake, but also provided better cash flow terms to the supplier. As such, they were able to signup nearly every small hotel in Europe. This resulted in more selection for the consumer and more support from the supplier base. Dennis Schall at  Skift.com has a wonderfully detailed account of how Booking.com came to dominate Europe, along with a more recent article addressing the lingering ramifications of the industry’s natural shift to the lower friction (lower rake) agency model.

It turns out that the average rake at Priceline Group  is even higher today, as they allow merchants to voluntarily bid up their rake for better placement in the network (you can see this in the table above). This is one of my favorite marketplace business model “tweaks.” You start with a low rake to get broad-based supplier adoption, and you add in a market-driven pricing dynamic that allows those suppliers who want more volume or exposure to pay more on an opt-in basis. This way no one leaves the network due to excessive fees, yet you end up with a higher average rake over time due to the competitive dynamic. And when prices go up due to bidding and competition, the suppliers blame their competition not the platform (part of the genius of the Google AdWords business model). This also allows you to extract more dollars from those suppliers who desire to spend more to promote themselves (without raising the tax on those that don’t).

Here is another interesting story related to rakes. In 2006, Benchmark started spending time with Gary Swart and the team at oDesk. We were quite enamored with their marketplace for skilled global talent, and were amazed at how the tools in their online workplace allowed customers to hire, manage, and pay for work from distributed teams. Combined with a bidding and reputation system, oDesk had built an “ebay for work.” At the same time, there were several larger players in the market such as Freelancer and Rent-a-coder. After discussing competition at length, the team came upon the idea of lowering the commission from 30% (which was standard in the industry) to 10% of overall costs. We were excited to hear such aggressive strategic thinking from the team, and they were excited to hear from an investor with a long-term perspective (this change obviously reduced current period revenue to 1/3 of its current level).  The rest is history. By 2009 oDesk surpassed the nearest competitor, and they are now the clear leader (larger than their top competitors combined) in the rapidly emerging “online work” industry.

All of which leads us to two very interesting rake examples that are front and center in today’s Internet – Facebook and Apple. Both of these companies charge a hefty 30% fee for transactions on their platform. Because most of the developers building on these platforms make software, the developers do not experience immediate pain when they share 30% of top-line revenue. After all, marginal costs are near zero, and therefore the fee is tolerable. But the real question is: Does the 30% marketplace on top of the platform help to reinforce the strategic positioning of the platform itself? Or is it merely a revenue extraction exercise? And if so, is there a risk that a “rake too far” could be a net-negative from a strategic standpoint?
Let’s start with Facebook. For the first several years, Facebook’s application platform was a smashing success. The distribution power of their pervasive platform proved a remarkable vehicle for many companies; particularly games companies. The platform was so successful so quickly that many early adopters of the platform rocketed to hundreds of millions in sales. Zynga, which was particularly adept at surfing the Facebook wave, catapulted to $1 billion in revenue in its sixth year of existence! Everything looked incredible. Fast-forward to today (only a few years later), and games companies are no longer betting their whole company on Facebook. Oddly, they are aggressively and strategically looking to expand non-FB distribution.

It is really hard to pinpoint exactly what went wrong. One might question Facebook’s commitment to being a game platform. Some might also highlight the lack of breadth in its success, and argue that Zynga had it “too good” versus other players in the field. And some might point to the rise of mobile which created a difficult platform transition for Facebook (which we will address shortly). In addition to these issues, there is also a strong argument that 30% was simply an excessive rake.

When you consider that many of these same game companies were also large buyers of Facebook’s ad products, it suggests that the “actual” rake, the real cost of being competitive on the platform, was much higher than 30%. Given Facebook’s position as the leading global social network with high barriers to entry, there was no need to maximize revenue on day one. It was far more important to prove the platform as a viable and efficient distribution mechanism for a broad range of products and services, and to convince all partners of the unquestioned efficacy of the platform itself.

Last November, Zynga and Facebook together renegotiated their previous long-term business agreement. According to the old agreement, Zynga was required to shell out 30% of their revenue even if they generated revenue “off Facebook”.  That is a very aggressive rake. Now Zynga is freed from many commitments it had made to the Facebook platform, and is allowed to build independent revenue streams outside of Facebook. The reality is that Zynga is still highly dependent on Facebook. However, Zynga shareholders are now tracking Zynga’s percentage of revenue tied to Facebook and consider it a positive if they can reduce this dependency. The bottom line is that the entire gaming industry has lost some of its enthusiasm for the Facebook platform, and it will be difficult for Facebook to recreate the magic and momentum they once had.

The Apple case is more extreme as the impact is more consequential. Despite the fact that Apple had/has industry leading hardware margins on its incredible computing products, Apple felt the need to take 30% of the revenue that was created by its app ecosystem as well as 30% of the revenue from media rentals and sales. In retrospect, demanding to be paid on both sides was a sign of overconfidence. However, the truth is they made this work for a very long time. Many companies, thriving on the Apple platform, didn’t exist and wouldn’t exist were it not for iOS. For itself, Apple has created billions and billions of high margin revenue and corresponding bottom line profits as a result of the amazing success of its 30% rake. All of which helped catapult Apple to the very top of the business hierarchy – the largest market capitalization company in the world.

The single-biggest problem with Apple’s aggressively high rake was its impact on potential long-term strategic partnerships. Specifically, two companies that potentially could have helped to reinforce the success of the iOS platform blinked, paused, and then went on to support a competitive platform. Both Amazon and Facebook could have been and should have been BFFs with Apple. And if Apple could go back in time, they would surely opt to be BFFs also. The most threatening company for all three players was clearly Google. However, Amazon owns a digital media business built around Kindle. And Facebook, as discussed, has a 30% rake business helping game developers distribute and monetize games throughout its network. When Facebook and Amazon read the terms of service of the iOS platform, and came to grips with the reality of the 30% rake, they saw an instant road-block – a show-stopper to their potential success on that platform. It was very hard to imagine their business model and Apple’s business model coexisting, and so they eventually punted on a full commitment to iOS.

The bottom line is they could have been amazing partners. If Apple had a lower rake, or even had they been less obstinate about their existing rake, a partnership could have formed (ask anyone in Hollywood – “splits” can solve any problem). iOS could have been both the definitive Facebook mobile device, AND the definitive Amazon shopping device. They could have been integrated from the beginning at a deep level: your social network in contacts; your Amazon 1-click credentials a fingertip away. Jeff Bezos, Mark Zuckerburg, and Steve Jobs on a stage together talking about the truly amazing things these companies have done together. It could have been awesome. But it didn’t play out that way.

Instead, as you are aware, Facebook’s new Home mobile application is available only on Google’s Android, Apple’s key nemesis of the past decade. There are currently no plans to offer Home on iOS, and Eric Schmidt, Google’s esteemed Chairman, cheered along in appreciation at the recent Dive Into Mobile Conference, “I think it’s fantastic — I love it,” Schmidt said. Instead of becoming a platform differentiator for Apple, Facebook is now aiding and abetting Apple’s only real competition.

The Amazon situation vis-a-vis Apple is more severe. In stiff-arming Amazon over its “30%” Apple not only alienated a key partner but launched a competitor. Amazon has obviously designed its Kindle Fire system on top of an Android variant. But that is only half the problem. Amazon, in true Amazon fashion, is now attacking Apple’s exposed business underbelly: the fat margins they receive by charging both high hardware margins and a high rake on content. As outlined in its recent Letter to Shareholders, Amazon does not believe that its customer should have to pay fat margins on hardware AND content. “Our business approach is to sell premium hardware at roughly breakeven prices. We want to make money when people use our devices – not when people buy our devices.” Amazon plans to subsidize the hardware platform and live solely on the content margin. The 30% rake basically launched a nasty competitor with a disruptive pricing model.

Number one on the list of Peter Drucker’s Five Deadly Business Sins is “Worship of high profit margins and premium pricing.” As Drucker notes: “The worship of premium pricing always creates a market for the competitor. And high profit margins do not equal maximum profits. Total profit is profit margin multiplied by turnover. Maximum profit is thus obtained by the profit margin that yields the largest total profit flow…” Most venture capitalists encourage entrepreneurs to price-maximize, to extract as much rent as they possibly can from their ecosystem on each transaction. This is likely short-sighted. There is a big difference between what you can extract versus what you should extract. Water runs downhill.

[After this post was written, several readers pointed out that perhaps the most amazing example of using lower pricing to disrupt a marketplace leader was Taobao vs eBay in China. If the pending IPO of Taobao's parent, Alibaba.com, is half as big as people expect, than this may have been the ultimate marketplace pricing win of all time.]

*Please let us know if you have other names you would add to the table, or if there are numbers you think need correcting. I will update the table and put the rolling updates in the answer to this quora post on the same topic.

Several others have posted their favorite longreads of the year (you can find them here).  Unfortunately, I did not keep track as much as I should have. Next year I aim to do better. With that caveat, here are a few of my favorite long-form articles from last year.

A Basketball Fairy Tale in Middle America, by Sam Anderson (New York Times Magazine)

This article ran as a cover story in the November 8th issue of the New York Times Magazine. Like many great longreads, this article is about much more than its core subject, which in this case is a basketball team. It dives deep into the ethos of the city, and the elements of the Thunder team that make it much more special than your ordinary NBA team. Durant of course plays a huge role, but there are many more nuanced elements certain to drive any Seattle basketball fan to the edge of tears. Thanks to Sam Anderson for making me even more of an OKC fan than I already was.

The Most Amazing Bowling Story Ever, by Michael Mooney (D Magazine)

It really doesn’t matter if you are into bowling or even if you are a sports fan. You still should read The Most Amazing Bowling Story Ever, from the July issue of D Magazine. Well written nonfiction begs you to finish it all in one sitting. In The New Journalism, Tom Wolfe argued that properly written nonfiction could be more compelling than fiction. If the world ever wants a movie about bowling, the screenplay is already written. Prior to this article, I was unfamiliar with Michael Mooney’s work, but I will be watching going forward. Fantastic.

The Man Who Broke Atlantic City, by Mark Bowden (Atlantic Magazine)

This article chronicles the gambling success of Don Johnson, who more than once walked away from Atlantic City casinos with outsized wins. What is great about this story is how the hero capitalizes on the greed of the casino managers. He was able to persuade them to relax their rules, which allowed math back into the equation. You wonder how many of these stories never get told (which would seem appropriate).

Scamworld by Joseph Flatley (The Verge)

Turning towards the Internet, Joseph Flatley’s Scamworld is a look inside the dark underbelly of “Internet Marketing.” For many, the trick of the close is much more important than what is actually sold. Flatley is focused specifically on online criminals, but the tools they use are eerily similar to a subset of startups that live in the vast grey-zone of Internet marketing activities.

Why the Clean Tech Boom Went Bust, by Juliet Eilperin (Wired Magazine)

Ambition, passion, intelligence, and a boat-load of money can only take you so far. You still need physics and economics on your side. Wired Magazine often surprises with a contrarian viewpoint, and in this case published an article everyone else was afraid to write. If you want your venture to succeed, it must succeed as a business – eventually.

Is Sugar Toxic, by Gary Taubes (New York Times Magazine)

Technically, this article was published in 2011, but that should not stop it from being further distributed. Gary Taubes, as well as others, have uncovered the real cause of America’s obesity. Michael Bloomberg may look silly trying to outlaw mega-sodas, but at the very least he is calling attention to the proper villain. This is an amazing lesson in how everyone can get it wrong for decades – the scientists, the government, and the doctors.

Cormac McCarthy’s Apocalypse by David Kushner (Rolling Stone)

This one will cost you money, but the subject matter is interesting and the money goes to a great cause. Cormac McCarthy’s Apocalypse (originally published in 2007) is offered as premium content behind the Longreads subscription wall. America’s most treasured modern novelist happens to be a consistent presence at one of America’s most interesting research institutions, the Santa Fe Institute. Friends I know close to Santa Fe confirm that he is not merely present, but also an active and skilled participant. I also understand he may have “edited” one of my favorite longreads of all time, Brian Arthur’s Increasing Returns and the Two Worlds of Business from HBR in 1996.

Snow Fall: The Avalanche at Tunnel Creek by John Branch (New York Times Magazine)

This is perhaps the most interesting longread of the year. The subject matter is backcountry skiing, but that has little to do with Branch’s phenomenal achievement. The concept of computer generated “multi-media” dates back to the early 1990’s, which is the first time we could imagine text, pictures, audio, and video all combined in a single content offering. However, most efforts over the past 20 years appear to be a technology looking for a solution – there is no flow. Snow Fall may be a seminal accomplishment in multimedia where the insertion of each media type builds upon the story in a remarkably compelling way. I wouldn’t be surprised if this article takes on historical journalistic importance. Bonus: Q&A with the author.

In addition to longreads, I am equally enamored with great non-fiction video on the Internet. I have no doubt that one day there will be a very important and valuable company that categorizes and helps users discover great non-fiction Internet video. If you see a company in that space, please do me a favor and let me know. Until then, I will append a few video recommendations to my longreads list.

Jeff Bezos on Charlie Rose, November 16, 2012

Any interview with Jeff Bezos is a “must watch,” but this particular interview is my favorite of all time. Bezos is simultaneously admired on Wall Street and in Silicon Valley, filling the void left by Steve Jobs as the most admired leader in technology. He offers advice on everything from running a BOD meeting to maintaining innovation in a large company. The whole time he is remarkably on message (per Amazon) and remarkably happy. Eighteen years in and killing it.

Adam Darwin: Emergent Order in Biology and Economics by Matt Ridley

Two of my favorite innovative thinkers from history are Charles Darwin and Adam Smith. Left leaning philosophies favor Darwin and not Smith. Those on the right espouse Smith but not Darwin. Ironically, Darwin borrowed many of his ideas from Smith. Ridley discusses their similarities and why we would should embrace both perspectives.

Everything You Need to Know About Finance and Investing in Under an Hour by William Ackman

If you have studied finance or business you can easily skip this video. If however, you have never studied finance or business, and you are working on a startup, I would highly encourage you to spend 44 minutes with this video. It is quite enlightening and dense in data. Worth your time. Thanks to @vanninicapital.

Following our investment in Ebay, we have been fortunate enough to invest in several companies that link consumers and suppliers through a successful online marketplace. Companies such as OpenTable, Yelp, Zillow, oDesk, GrubHub, 1stdibs, UShip, and Uber have all reached significant scale within their respective markets. But we have also invested in several companies that we thought had marketplace opportunities that simply did not play out as expected. Simply put, some industries are much more susceptible to the arrival and success of online marketplaces than others.

A true marketplace needs natural pull on both the consumer and supplier side of the market. Aggregating suppliers is a necessary, but insufficient step on its own. You must also organically aggregate demand. With each step, it should get easier to acquire the incremental consumer AS WELL AS the incremental supplier. Highly liquid marketplaces naturally “tip” towards becoming a clearinghouse where neither the consumer nor the supplier would favor an alternative. That only happens if your momentum is increasing, and both consumers and suppliers are sensing an increasing importance of your place in the world. Much easier said than done.

Here are 10 factors to consider when evaluating the potential success of a new marketplace opportunity:

1. New Experience vs. the Status Quo. Great marketplaces do not simply aggregate a market; they enhance it. They leverage the connective tissue to offer the consumer a user experience that simply was not possible before the arrival of this new intermediary. OpenTable enables the consumer to search reservation availability across hundreds and hundreds of restaurants in a matter of seconds. That capability never existed before, and as a result the delta of the new experience vs. the incumbent experience (dialing restaurants one by one) is extremely high. Another company with a high experience delta is Uber. By aggregating thousands of licensed limousine drivers, and overlaying that with a new-age supply chain management solution, Uber gives it users an experience that is drastically improved compared to the previous alternative. Today, GrubHub announced “Track Your Grub”, a service that allows you to watch your food on the way to your house. When this experience delta is great enough, it creates “wow” moments for new users. “Wow” moments lead to word-of-mouth viral growth and high net promoter scores.
2. Economic Advantages vs. the Status Quo. Some marketplaces provide enhanced economic advantages. oDesk enables companies to easily provision programming talent from all corners of the globe. This helps purchasers procure a cheaper alternative, while also providing brand-new economic lift to the programmer (supplier). Both sides experience an economic advantage. Another interesting example of this bi-directional advantage is AirBNB. For the property owner, the income is “found money” that simply didn’t exist prior to the marketplace. And in many cases the consumer receives a better price as well. If you can positively change the economics of an industry, you will find the participants on both sides rooting for your success. This gives you a huge head start when it comes to tipping the marketplace.
3. Opportunity for Technology to Add Value. In many marketplaces, the technology offering greatly enhances the user experience. Zillow provides homebuyers with an abundance of data that was historically kept in proprietary systems. They have overlaid this data with maps and search technology that provide remarkable richness to the home buyer. Smartphones take this even further, with the ability to learn a great deal about any property with a one-click GPS enabled search. At Uber, the system has “perfect” information in an industry where just two years ago there was a complete lack of visibility (on both sides of the network) that led to enormous waste of resources. Uber’s system enables higher car utilization, more fares per hour for the driver, and faster and faster pickup times for the consumer. At oDesk, the platform enables the planning, development, and transfer of code from the supplier to the purchaser. The marketplace is also a work-flow system that enhances the overall experience for all parties. Facilitating work-flow reduces work for the participants, as well as increasing switching costs.
4. High Fragmentation. High buyer and supplier fragmentation is a huge positive for an online marketplace. Likewise, a concentrated supplier (or purchaser) base greatly diminishes the likelihood of a successful online marketplace. A highly concentrated supplier base will be reluctant to allow a new intermediary in their market, and as a result will likely fight rather than support your arrival. They will also be very reluctant to share in the economics of the industry, as anyone in the online travel industry can confirm. The large airlines have all but obliterated the economics of online ticketing marketplaces, leading all the online players to focus on hotels where the fragmentation and therefore the economics are higher. If you look at the list above of successful Benchmark investments, you will see a common theme of fragmented supplier base.
5. Friction of Supplier Sign-Up. In some markets signing up suppliers is relative easy. In others, it can be a painfully slow process that requires lots of touch and local presence. At companies such as Yelp, Uber, and GrubHub, new city launches are relatively quick after a process model had been established for how to launch those cities. The opposite was true for OpenTable where the installation of a personal computer and internet connectivity were part of the early roll-out requirements. High friction supplier signup can be a barrier to entry (as it is for OpenTable) if you are able to build a successful marketplace.  But in the early stages, this friction slows your roll-out and increases the costs associated with supplier aggregation. Remember, however, that supplier aggregation is the easy part. Aggregating demand is much harder and more critical.
6. Size of the Market Opportunity. A proper TAM (total available market) analysis is imperative, but it is easy to make mistakes looking only at TAM. As a starter, if all the other factors are negative, it will not matter that the market is large. Some markets are crappy candidates for marketplaces. Second, you should also consider the percentage of the market that is likely to use the online alternative. In certain industries, there may be large portions of the market that may not be available to the new online marketplace. An interesting example is healthcare, which is unquestionably a very large market. However, the oligopoly of large players in this market controls a massive percentage of market and is unlikely to support a new alternative. You can also miss-analyze TAM in the other direction. In the case of OpenTable many investors missed the opportunity by mistakenly assuming the TAM was too low. In this case, they underestimated the percentage of the market that OpenTable could penetrate. OpenTable recently passed 10 million diners a month with less than 20% of transactions in North America currently online. You must combine a TAM analysis with the likelihood of marketplace success and penetration.
7. Expand the Market.  Another potential error that can be made while analyzing TAM is to fail to understand that the features and enhancements of the new marketplace may actual expand the market opportunity for the whole industry. This may sound like a brazen claim, but certain marketplaces do indeed expand the market — by exploring new price points or enhancing convenience or usability. oDesk greatly simplifies the process of outsourcing code development, and as such many of its use cases are expansive to the overall market. oDesk’s presence increases the number of first time software outsourcers. Uber’s ease of use and simplicity have led many of its users to greatly increase the number of times they use an alternative car service. Some customers now use it as a second car alternative. As such, the company is meaningfully expands the market for black car services, which is in turn a huge boon to the suppliers that share in the economic expansion.
8. Frequency. All things being equal, a higher frequency is obviously better. Yelp, GrubHub, OpenTable, 1stdibs (for the designer) and Uber are all high frequency use cases, where the consumers can rely on the marketplace as a utility. Many failed marketplaces attack purchasing cycles that are simply way too infrequent, which makes it much more difficult to build brand awareness and word-of-mouth customer growth. Another repeated mistake is attacking verticals where a satisfactory supplier “match” end’s the customer’s need to re-enter the market in search of an alternative. This second point negatively impacts many vertical service provider markets (such as pediatricians) where customers are actually prefer a monogamous relationship.
9. Payment Flow. All things being equal, being part of the payment flow is superior to not being a part of the payment flow. This is due to the fact that it is much easier to extract reasonable economics when you are in the flow of payment. The supplier not only looks to you as a provider of revenue, but they receive that revenue “net of the fee.” Contrast this with a marketplace where you add value first, and then send a bill to the supplier at later date for services rendered. In this latter case the marketplace appears as an expense, and it’s easier for the supplier to view it is a “tax” versus a distribution relationship. Cash is king, and if you bring the cash, you are king. Unfortunately, some industries (like autos) just are not set up for this type of arrangement, as the payment likely lives at the end of a long purchasing process.
10. Network Effects. Network effects are tricky and hard to describe but fundamentally turn on the following question: Can the marketplace provide a better experience to customer “n+1000” than it did to customer “n” directly as a function of adding 1000 more participants to the market? You can pose this question to either side of the network – demand or supply. If you have something like this in place it is magic, as you will get stronger over time not weaker. In the early days of OpenTable we noticed that the reservations per restaurant in a given city were correlated to market penetration. Clearly, the more restaurants that were on the network, the better the value proposition was for the consumer. Something similar occurs with Uber. As the company grows, they are able to facilitate more cars on the road, and along with their investment in route and load optimization, this allows for shorter and shorter pickup times. The experience gets better and better the longer they are in the market. UGC sites like Yelp and TripAdvisor also have strong network effects. Network effects are rare but golden. If you don’t have one try to find one; if you do have one, try to enhance it.

It is unlikely that you will find a marketplace opportunity that would score ten out of ten with respect to this list. However a 7 or 8 out of 10 would imply that your opportunity of success is much, much higher than if you only match 3 or 4 out of 10.  It is also important to realize that finding a great opportunity is only a start, and this analysis could easily mislead one into underestimating the critical role that execution plays when it comes to marketplace businesses. Great marketplace execution is more nuanced and less systematic than other venture backed categories, and for every successful marketplace, you will find an amazing entrepreneur that out-executed the many others that had chosen to attack the same market. In addition to great marketplace characteristics, you also need a world-class entrepreneur to make the dream come true.

*For a real-time look at this analysis in action, see Our Most Recent Marketplace Investment, DogVacay from Los Angeles.

The most recent Above the Crowd blog post, titled All Marketplaces Are Not Created Equal, outlines ten different ways to judge the potential effectiveness of an online marketplace. You may be surprised how well DogVacay checks out against this list:

After taking a detailed look at the crowd-sourced dog care market; we became quite excited about the opportunity at DogVacay. In addition to our analysis, we had the added benefit that the company had been live since March, and we were able to confirm our analysis by witnessing amazing early traction in the field. DogVacay’s six-month ramp and current monthly gross transaction revenue are very reminiscent of the very best of our previously funded successful marketplaces. From out perspective, DogVacay is a winner in the making.

We are super excited to be working with Aaron Hirschhorn, the founder and CEO of DogVacay. He is not only an amazingly smart entrepreneur, but also a passionate dog owner. We are also thrilled to be working with First Round once again (as in Mint, Uber), and are excited about our first partnership with Peter Pham, Mike Jones, and the team at Science in Los Angeles.

This is a simplified version of the formula:

The key statistics are as follows:

• ARPU (average revenue per user)
• Avg. Cust. Lifetime, n (This is the inverse of the churn, n=1/[annual churn])
• WACC (weighted average cost of capital)
• Costs (annual costs to support the user in a given period)
• SAC (subscriber acquisition costs, sometimes refereed to as CAC = customer acquisition costs)

The LTV formula, when used correctly, can be a good tactical tool for monitoring and comparing like-minded variable market programs, especially across channels. But like any model, its proper use is entirely dependent on the assumptions used in that model. Also, people who have a hidden agenda or who confuse a model with reality can misuse it. For many companies that subscribe to its wisdom, the formula slowly takes on more importance than it should. Seduced by the model, its practitioners often lose sight of the more important elements of corporate strategy, and become narrowly fixated on the dogmatic execution of the formula. In these cases, the formula can be confused, misused, and abused, much to the detriment of the business, and in many cases the customer as well.

Here are ten reasons to avoid worshiping at the LTV altar:

1. It’s a Tool, Not a Strategy.  Heavy LTV companies forget that the LTV model does not create sustainable competitive advantage. You shouldn’t’ confuse output with input. The LTV formula is a measurement tool to be used by marketing to test the effectiveness of their marketing spend – nothing more and nothing less. If one asserts that buying customers below what they charge them is a corporate strategy, this is in essence an arbitrage game, and arbitrage games rarely last. Too many of the variables (specifically ARPU and SAC) are outside of your control, and nothing would prevent another player from executing the exact same strategy. It’s not rocket science; it’s a formula that any business school graduate can calculate. Do not fool yourself into believing it creates a proprietary advantage.
2. The LTV Model Is Used To Rationalize Marketing Spending.  Marketing executives like big budgets, as big budgets make it easier to grow the top line.  The LTV formula “relaxes” the need for near term profitability and “justifies” the ability to play it forward – to spend today for benefits that are postponed into the future. It is no coincidence that companies that put a heavy emphasis on LTV are also the ones that have massive losses as they scale, frequently even through an IPO. Consider that most companies limit any “affiliate fee” they would be willing to spend to 5-10% of sales. Yet when they are marketing, they use different math. They use LTV math, and all the sudden it’s acceptable to spend 30-50% of revenue on customer acquisition. Find the most boisterous executive recommending excessive spending, and you will usually find a loyal servant of the LTV religion.
3. The Model is Confused and Misused. Frequently the same group that is arguing for more spending is the same one that “owns” the LTV calculation. (This is a mistake – finance should monitor LTV).  As a result, it is not uncommon for one to see shortcuts taken that allow for greater freedom. As an example, marketers often divide spend by total customers to calculate SAC rather than just those customers that were “purchased.” If you have organic customers, they shouldn’t be included in the spend calculus. They would have arrived regardless of spend. Also, many people discount “revenues” rather than marginal cash contribution. It is critical to bundle all future variable costs of supporting the customer in order to fairly estimate the future contribution. As an example of the sloppiness that exists around the formula, consider this blog post (http://blog.kissmetrics.com/how-to-calculate-lifetime-value/) from KISS metrics, a company whose aim is to “help you make smarter business decisions.” Not only do they include a version of the model that specifically ignores future costs, but also they recommend taking an average of three different results, two of which are clearly flawed. This voodoo-math has no place as part of a multi-million dollar marketing exercise.
4. Business Isn’t Physics – The Formula Is Not Absolute. LTV zealots often hold an overly confident view of the predictive nature of the formula. It’s not “hard science” like say predicting gravity. It’s at best a “good guess” about how the future will unfold. Businesses are complex adaptive systems that cannot be modeled with certainty. The future LTV results are simply predictions based on many assumptions that may or may not hold. Yet the LTV practitioner often moves forward with a brazen naiveté, evocative of the first time stock buyer who just found out about the price/earnings ratio, or the newcomer to Vegas who has just been taught the basics of twenty-one. LTV models win arguments because executives perceive them to be grounded in science. Just because its math, doesn’t mean its good math.
5. The LTV Variables “Tug” at One Another. This may be the single most important issue and it lies at the heart of why the LTV model eventually breaks down and fails to scale ad infinitum. Tren Griffin, a close friend that has worked for both Craig McCaw and Bill Gates refers to the five variables of the LTV formula as the five horsemen. What he envisions is that a rope connects them all, and they are all facing different directions. When one horse pulls one way, it makes it more difficult for the other horse to go his direction. Tren’s view is that the variables of the LTV formula are interdependent not independent, and are an overly simplified abstraction of reality. If you try to raise ARPU (price) you will naturally increase churn. If you try to grow faster by spending more on marketing, your SAC will rise (assuming a finite amount of opportunities to buy customers, which is true). Churn may rise also, as a more aggressive program will likely capture customers of a lower quality. As another example, if you beef up customer service to improve churn, you directly impact future costs, and therefore deteriorate the potential cash flow contribution. Ironically, many company presentations show all metrics improving as you head into the future. This is unlikely to play out in reality.
6. Growing Becomes a Grind. Let’s say you have a company that estimates it will do $100mm in revenue this year, $200mm the next, and $400mm the year after that. In order to accomplish those goals it is going to invest heavily in marketing – say 50% of revenues. So the budget for the next three years is $50mm, $100mm, and $200mm. How realistic is it to assume that your SAC will drop as you 4X your spend? Supply and demand analysis suggests the exact opposite outcome. As you try to buy more and more of a limited good, the price will inherently increase. The number one place on the planet for marketing spend is Google Adwords, and make no mistake about it, this is an increasingly finite resource. Click-outs are not growing at a meaningful pace, and key word purchases are highly contested. Assuming you will “get better” at buying while trying to buy more is a daunting assumption. The game will likely get tougher not easier.
7. Purchased Customers Underperform Organic on Almost Every Metric. Organic users typically have a higher NPV, a higher conversion rate, a lower churn, and more satisfied than customers acquired through marketing spend. LTV heavy companies are in denial about this point. In fact, many of them will argue until they are blue in the face that the customer dynamics are the same while this is rarely the case. A customer that “chooses” your firm’s services will be much more staisfied than one that is persuaded to buy your product through spend. Find any high-marketing spend consumer subscription company, and I will show you a company with numerous complaints at the Better Business Bureau. These are companies that make it almost impossible to terminate your subscription. When you are scheming on how to trap the customer from finding the exit you are not building a long-term brand.
8. The Money Could Go to the Customer.Think about this. If you are a company that spends millions and millions of dollars on marketing, wouldn’t you be better off handing that money to the customer versus handing it to a third-party who has nothing to do with the future life-time value of the customer? Providing a better value-proposition to the customer is much more likely to endure goodwill than spending on marketing. A heavy marketing spend necessitates a higher margin (to cover the spend), and therefore a higher end user price to the customer! So the customer is negatively impacted by the presence or “need” of the marketing program. Plus, a margin umbrella now exists for competition that chooses to undercut your margin model with a more efficient customer acquisition strategy (such as giving the customer the money).“More and more money will go into making a great customer experience, and less will go into shouting about the service. Word of mouth is becoming more powerful. If you offer a great service, people find out.” – Jeff Bezos
9. LTV Obsession Creates Blinders. Many companies that obsess over LTV, become overwhelmed by LTV. In essence, the formula becomes a blinder that restricts creativity and open-mindedness. Some of the most efficient forms of marketing are viral, social, and effective PR (public relations). Most companies that obsess about LTV are less skilled at these more leveraged techniques. Ironically, it’s the scrappy and capital starved startup with absolutely no marketing budget that typically finds a clever way to scale growth organically.  I love this historic slide from Skype comparing their SAC with that of Vonage, an iconic disciple of LTV analysis.

10. Tomorrow Never Arrives.  The Utopian destination imagined by the LTV formula is a mirage. It almost never works out as planned in the long run. Either growth begins to slow, or you run out of capital to continue to fund losses, or Wall Street cries uncle and asks to see profitability. When this happens the frailty of the model begins to appear. SAC is a little higher than expected. You met your growth target, but the projected loss was bigger than expected. Wall Street is hounding you for churn numbers, but you are reluctant to give them out. The lack of transparency then leads to cynicism, and everyone assumes the worse. It turns out that the excessive marketing spend was also propping up repeat purchase, and pulling back to achieve profitability is increasing churn. Moreover, a negative PR cycle has ensued as a result of your stock decline, and the press’ new doubts about your model. This also impacts results, and customer perception of your brand. The bottom line is that “one day we can stop spending and be remarkably profitable” rarely comes to fruition.

It is not impossible to create permanent equity value with the LTV approach, but it’s a dangerous game of timing – you don’t want to be the peak investor. Let’s say a new business starts with an early market capitalization of A (see graph below). Through aggressive marketing techniques, and aggressive fund raising, the company is able to achieve amazing revenue growth (and corresponding losses), but nonetheless creates a rather sizable organization. At this point, the company is value at point B. Eventually, however, gravity ensues and the constraints outlined herein raise their head, resulting in a collapse to point C.  For early founders and investors at point A, they may do OK (as long as C>A), but it will be accomplished on the backs of later stage investors that helped fund the unsustainable push to point B. This is the story of many a telecom and cable provider expansion history, as well as a few recent Internet companies.

This should not be misconstrued as a eulogy for the LTV formula. It has a very important place in business as a way to contrast and compare alternative marketing programs and channels. It is a tactical marketing tool that requires candor and thoroughness in its implementation. The fundamental reason that it is so amazingly dangerous and seductive is its simplicity and certainty. Generic marketing is conceptual. LTV marketing is specific. Building a plan to grow to a million users organically is an order of magnitude more difficult than doing it with the aid of the LTV formula. There is comfort in its determinism, and it is simply easier to do.

Some people wield the LTV model as if they were Yoda with a light saber; “Look at this amazing weapon I know how to use!” Unfortunately, it is not that amazing, it’s not that unique to understand, and it is not a weapon, it’s a tool. Companies need a sustainable competitive advantage that is independent of their variable marketing campaigns. You can’t win a fight with a measuring tape.

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.

Great entrepreneurs often blaze their own trails, and the founder and CEO of Demandforce, Rick Berry, is no different. In a day and age of social media, where many companies project a persona much larger than reality, Demandforce chose instead to focus on its customers and its products. We never even announced Benchmark’s funding of the company, which I believe is unprecedented. The Demandforce team always felt that the attention should be focused on the customer rather than the company.

Demandforce’s customer mission has always been the same – to help small businesses thrive in an evolving and increasingly complex connected world. Today, they are the leading provider of interactive “front office” SAAS services to thousands and thousands of professional small business owners. The Demandforce product is a powerful web-based application that seamlessly integrates with existing workflow systems, works automatically, and delivers guaranteed results. Through this, Demandforce provides local businesses – like salons, auto shops, chiropractors, dentists, and veterinarians – with affordable and easy access to the tools and platforms that large enterprises use to communicate with customers, build a strong online reputation and leverage network marketing. It you have ever received an automated communication from your dentist, it was likely sent through Demandforce.

Demandforce’s success puts it at the forefront of the burgeoning “Local Internet” wave. The combination of Internet pervasiveness and smartphone penetration has led to a complete reconfiguration with regard to how local businesses interact with their customers. These local businesses have traditionally spent over $125B/year on traditional media, and this is only in the U.S. But the channels they have historically used, such as the newspaper and the yellow pages, are increasingly compromised. These business owners know they need new solutions, and these dollars will be reallocated to these exciting new platforms. Benchmark believes this “Local Internet” wave is many times larger than the “social” and “mobile” themes with which it is often contrasted. In addition to DemandForce, Benchmark is fortunate to have backed such “Local Internet” market leaders as OpenTable (OPEN), Zillow (Z), Yelp (YELP), Peixe Urbano, GrubHub, Uber, and Nextdoor.

It has been an honor and a pleasure to work with Rick Berry, Patrick Barry, Hoang Vuong, Mark Hale, Sam Osman and Annie Tsai at Demandforce. This is truly one of the best teams ever assembled. It was also a pleasure to work with Steve Kostyshen as well as Mike Maples of Floodgate and Peter Ziebelman of Palo Alto Venture Partners, all of whom preceded us in their investment, and all of whom are passionate fans of the company.

It is certainly thrilling to see a team of entrepreneurs reach a significant milestone such as this.  That said, it is equally bittersweet as it means we will no longer be working directly with them on this incredibly compelling mission. Our loss is unquestionably Brad Smith and Intuit’s gain. Combining the leading “front office” small business SAAS vendor with the iconic Silicon Valley small business company is an incredibly compelling combination.

1) With regards to core search, the Bing results were perfectly fine. I never struggled to find anything. I never forced myself to redo the search on Google. So I would say Bing is on-par in terms of traditional, core search quality.

2) Where I did struggle was with the non-core search searches (i.e. maps, images, videos, news). Microsoft and Google use slightly different UIs on these non-core searches, and I had no idea how trained I was on the Google UI. Trying to learn the Bing tools and features was quite frustrating, and on those searches – I kept returning to Google. Plus, I didn’t realize how often I transition from one type of search to another (from core to maps, or core to news). This was another point of frustration. Keep in mind, I did not have a problem with Bing’s non-core results, just rather the navigational elements.

At the end of the day, for me, my user “lock-in” is associated not with the quality of Google results, but rather with the understanding of the UI features and levers.  More like a traditional software application.

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A few relevant scenes from the recent blockbuster Moneyball:

Peter Brand: Billy, Pena is an All Star. Okay? And if you dump him and this Hatteberg thing doesn’t work out the way that we want it to, you know, this is…this is the kind of decision that gets you fired. It is!
Billy Beane: Yes, you’re right. I may lose my job, in which case I’m a forty four year old guy with a high school diploma and a daughter I’d like to be able to send to college. You’re twenty five years old with a degree from Yale and a pretty impressive apprenticeship. I don’t think we’re asking the right question. I think the question we should be asking is, do you believe in this thing or not?
Peter Brand: I do.
Billy Beane: It’s a problem you think we need to explain ourselves. Don’t. To anyone.
Peter Brand: Okay.

These two scenes from Moneyball illustrate something that may be essential to modern business: the incredible value of youth and innovative thinking relative to traditional experience. It turns out that the Moneyball character Peter Brand’s real name is not Peter Brand (played by Jonah Hill), but rather Paul DePodesta. And he didn’t go to Yale, but instead Harvard. He was indeed young – twenty-seven when he went to work for Billy Beane – and he did have an actual degree in Economics. What’s more, as you can see in the interaction above, Billy valued Paul’s (Peter Brand’s) opinions and decisions – despite the fact that he was a complete novice with respect to baseball operations.

A month or two ago, I had the unique opportunity to share the stage with Billy Beane at a management offsite for one of the leading companies in the Fortune 500. We were both fielding questions about innovation, and what one can do to keep their organization innovative. I talked about how many of the partners that have joined Benchmark Capital have been extremely young when they joined, including our most recent partner Matt Cohler who joined us at the age of 31. At Benchmark, we believe that young partners have many compelling differentiators. First, they will ideally have strong connections and compatibility with young entrepreneurs, who are frequently the founders of the largest breakout companies. They are also likely to be frequent users of the latest and greatest technologies (all the more important with today’s consumer Internet market). Like the “Moneyball” situation described herein, young VCs are open to new ways of doing things. This form of “rule-breaking,” or intentionally ignoring yesterday’s doctrine, may in fact be a requirement for successful venture capital investing.

When I mentioned this intentional bias towards youth, Billy Beane abruptly concurred. He noted that injecting youth into the A’s organization is also a key philosophy of his. Paul DePodesta may have been the first young gun that Billy hired, but he was far from the last. Billy continues to recruit young, bright, talented people right out of college to help shake up the closed-minded thinking that can develop with an “experience only” staff. Also noted was the fact that if a certain “experience” is shared by all teams in the league, then it is no longer a strategic weapon. You can only win with a unique advantage.

The impact of youth on the technology scene is undeniable. The included table lists the founding age of some of the most prominent founders of our time. The facts are humbling and intimidating, especially for someone who is no longer in their twenties or early thirties. Can someone in their forties be innovative? Or, do the same things that produce “experience” constrain you from the creativity and perspective needed to innovate?

Lets look at some of the specific advantages of youth. First, as mentioned before, without the blinders of past experience, you don’t know what not to try, and therefore, you are willing to attempt things that experienced executives will not consider. Second, you are quick to leverage new technologies and tools way before the incumbent will see an opportunity or a need to pay attention. For me this may be the bigger issue. The rate of change on the Internet is extremely high. If the weapon du jour is constantly changing, being nimble and open-minded far outweighs being experienced. Blink and you are behind. Youth is a competitive weapon.

The point Billy raised regarding the fleeting value of experience is also important to consider. As the world becomes more and more aware of a trick or a skill, the value of that experience begins to decay. If word travels fast, the value of the skill diminishes quickly. Best practice becomes table stakes to stay-afloat, but not to get ahead. We see examples of this every day with Facebook application user acquisition techniques. Companies find a seam or arbitrage that creates a small window of opportunity in the market, but quickly others mimic the same technique and the advantage proves fleeting.

Back before the Yahoo BOD hired Carol Bartz, there was much speculation about the important traits for Yahoo’s next CEO. Most of the analysis honed in on two key traits for the company’s next leader – the ability to lead and the ability to innovate. I remember trying to think about leaders that I thought would have a chance at having a measurable impact. On one hand, you could put a very young innovative executive into the role, but it is hard to imagine handing a $15B public company over to someone remarkably inexperienced. The other side of the coin is equally difficult – thinking of a seasoned executive who has the ability to dramatically innovate Yahoo’s products and business model.

There were only a handful of people (as few as three) that I could think of at the time that fit this second profile. Thinking back now, they all shared the following characteristic: despite being experienced CEOs, these individuals all “thought young” i.e. they were open-minded and curious. And they did not believe that experience gave them all the answers. These type of executives love diving head-first into the latest and greatest technologies as soon as they become available.

If you want to stay “young” and innovative, you have no choice but to immerse yourself in the emerging tools of the current and next generation. You MUST stay current, as it is illusionary to imagine being innovative without being current. Also realize that the generational shifts are much shorter than they were in the past. If you were an innovative Internet company five short years ago, you might have learned about SEM and SEO. Most of the newly disruptive companies are no longer using these tools as paths to success – they have moved on to social/viral techniques. The game keeps changing, and if you are not “all-in” in terms of learning what’s new, than you may be falling rapidly behind.

Consider these questions:

1. When a new device or operating system comes out do you rush out to get it as soon as possible – just because you want to play with the new features? Or do you wait for the dust to settle so that you don’t make a mistaken purchase. Or because you don’t want to waste your time.
2. Do you use LinkedIn for all of your recruiting, or do you mistakenly think that LinkedIn is only for job seekers? How many connections do you have? Is your profile up to date? (When Yahoo announced Carol Bartz as CEO, I did a quick search on LinkedIn.  She was not a registered user.)
3. When you heard that Zynga’s Farmville had over 80MM monthly users, did you immediately launch the game to see what it was all about, or do you make comments about how mindless it is to play such a game? Have you ever launched a single Facebook game?
4. Do you have an Android phone or do you still use a Blackberry because your Chief Security Officer says you have to? I know many “innovators” who carry an iPhone and an Android, simply because they know these are the smartphones that customers use. And they want exposure to both platforms – at a tactile level.
5. Do you use the internal camera app on your iPhone because it’s easy, or have you downloaded Instgram to find out why 27mm other people use that instead?
6. Do you leverage Twitter to improve your influence and position in your industry or is it more comfortable for you to declare, “why would I tweet?,” before you even fully understand the product or why people in similar roles are leveraging the medium? Do you follow the industry leaders in your field on Twitter? Do you follow your competitors and customers? Do you track your company’s products and reputation?
7. How many apps are on your smart phone? Do you have well over 50, or even 100, because you are routinely downloading each and every app from each peer and competitor you can to see how others are exploiting the environment? Do you know how WhatsApp, Voxer, and Path leveraged the iphone contact list for viral distribution?
8. Do you know what Github is and why most startups rely on it as the key center of their engineering effort?
9. Have you ever mounted an AWS server at Amazon? Do you know how AWS pricing works?
10. Does it make sense to you to use HTML5 as your mobile solution so that you don’t have to code for multiple platforms? Does it bother you that none of the leading smartphone app vendors take this approach?
11. When you are on the road on business, do you let your assistant book the same old car service, or do you tell them, “I want to use Uber just to see how it works?”
12. When Facebook launched the new timeline feature did you immediately build one to see what the company was up to, or did you dismiss this as something you shouldn’t waste your time on?
13. Have you been to Glassdoor.com to see what employees are saying about your company? Or have you rationalized why it’s not important, the way the way the old-school small business owner formerly dismissed his/her Yelp review.

The really great news is that being a “learn-it-all” has never been easier. With the Internet, high-speed broadband, SAAS, Cloud-services, 4G, and smart-phones, you can learn about new things, 24 hours a day, no matter where you are or what you do. All you need is the internal drive and insatiable curiosity to understand why the world is evolving the way it is. It is all out there for you to touch and feel. None of it is hidden.

There are in fact many “over 30” executives who can go toe-to-toe with these young entrepreneurs, precisely because they keep themselves youthful by leaning-in and understanding the constantly evolving frontier. My favorite “youthful” CEOs are people like Marc Benioff and Michael Dell, who frequently can be found signing up for brand new social networking tools and applications. Reed Hastings has more than once answered Netflix questions directly in Quora.  Jason Kilar frequently communicates directly with his customers through Hulu’s blog. Rich Barton, the co-founder of Expedia and Zillow is one of those people carrying both an Iphone and an Android, and is constant learning mode. I would also include Mark Cuban, whose curiosity is voracious. The other NBA owners never saw him coming. And lastly, there is Jeff Bezos, who seems to live beyond the edge, imagining the future as it unfolds. Watch the launch of Kindle Fire in NYC, and you will have no doubt that Jeff plays with these products directly and frequently.

Our last table highlights the stats from the Twitter account of some of these “youthful,” learn-it-all executives (sans Mr. Bezos – we all wish he tweeted). If you don’t find this list interesting, think about the thousands and thousands of executives out there who are nowhere to be found with respect to social media. They take the easy way out, likely blaming their legal department. They intentionally choose not to learn and not to be innovative. And they refuse to indoctrinate themselves to the very tools that the disrupters will use to attack their incumbency. That may in fact be the most dangerous path of all.

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