Why Do So Many People Freak Out When They See 'Free' As Part Of A Business Model?

from the divide-by-zero dept

A bunch of folks have been sending in a blog post by entrepreneur Hank Williams apparently attacking the concept of "free" and blaming venture capitalists, saying that they're overfunding a bunch of startups allowing them to give away stuff for free and distort the natural market. There's a lot of things that are incorrect in his analysis. Let's go through a few of them. He kicks it off by suggesting that it's "inherently impossible to start a small self-sustaining business," though there are numerous small online business owners who would disagree with him. It's not inherently impossible at all. In fact, I'd say it's rather common.

He then claims "in the digital world, advertising, the only real revenue stream, cannot support a small digital business." This appears to be wrong on two counts. First, there are numerous small online businesses that are supported by advertising revenue. But, more importantly, the idea that advertising is "the only real revenue stream" is inherently wrong. Advertising certainly is one revenue stream -- and an important one at that -- but there are many business models where you can make money by leveraging "free" to make scarce goods more valuable. Advertising is one such business model (using "free" content to make someone's scarce attention more valuable), but it's hardly the only one.

Williams then yanks out the old line that "it is very hard to charge when your competition is free." That, of course, is ridiculous. It's the same thing as saying you can't compete. In a competitive market, prices will get pushed down to marginal cost, no matter what (driving out all profit), so businesses that survive innovate, in order to get an advantage above the marginal cost in order to profit. That doesn't change if the marginal cost is $0 or $10,000. The trick is merely in knowing what scarcity you can sell that can't easily be copied. If you're trying to sell something that is easily copied, then you're selling the wrong thing. You have no competitive advantage. That's not anyone's fault but the business owner. In fact, the only fault I'd pin on VC's is if they pushed their portfolio companies to go against these basic economics.

Finally, he says that a bunch of these companies embracing "free" need to die and then "with less "free" floating around, a more regular supply and demand dynamic can take hold." But that, too, is incorrect. The supply and demand curve includes a price of $0, and when the supply is infinite, the supply curve is flat at the $0 line. So, the proper supply and demand dynamic has taken hold: and it says the price should be free.

This isn't to pick on Williams, as others have made similar arguments in the past, and I'm always interested in understanding why people are so confused by this. In the end, I can only assume that it's a "divide by zero" problem. For most of history, it's been shown that people naturally have trouble understanding the concept of zero. We may think we do, but as soon as a zero enters an equation, people tend to freak out and assume a model is broken. Yet, if we trust the model and realize it's not broken -- good things start to happen. Many businesses have learned that they can embrace "free" not because of a bunch of VC funding, but because that's the natural economic state of the market, and it allows them to make many, many other things more valuable. The real business trick is in making sure those things that are made valuable are what you're selling.

Filed Under: economics, free, venture capital, zero

The SEC May Want To Have A Word With The Latest Venture Capitalist On The Block

from the not-quite-legal dept

A few weeks ago, we discussed why the idea of a P2P venture capital firm didn't make much sense. Having lots of people invest is the same thing as going public -- and doing that requires complying with all sorts of SEC regulations. Simply opening up shop and asking lots of people to invest is bound to cause problems. Apparently, that's not stopping some folks. Wired has an article about how the founder of Powerset (the massively hyped up search engine startup that hasn't even launched yet) has moved on to try to start a new venture capital firm that would take small investments from many people and use those funds to invest in "greentech" investments. This is a little different than the P2P VC firm that we talked about, and actually seems to resemble something from the dot com bubble: a company called meVC, that allowed the public to invest money, which was then invested in startups. Of course, the folks at meVC at least realized that soliciting funds from the public meant going public itself first, so as not to run afoul of SEC regulations. Even then, things didn't work out so well. From the sound of things, it's not clear that the guy behind this new effort even realizes that, as described, the fund itself is probably very much in violation of SEC rules, but I'm sure the SEC will be kind enough to inform him pretty quickly if he moves forward with those plans.

Filed Under: greentech, public trades, publicly financed, sec, venture capital

Isn't P2P Venture Capital Just Going Public?

from the the-SEC-might-have-an-issue-with-that... dept

As there appears to be a growing market for p2p lending services, that has some wondering if there's also a market for p2p venture capital as well. In p2p lending, a group of ordinary folks all team up to lend people money. The various players in the space have had somewhat mixed results so far, but there's a lot of attention. However, for most companies, getting access to capital involves options between taking out a loan (which needs to be paid back plus interest) or selling equity (usually to venture capitalists). In that case, the money comes from someone who takes some percentage of ownership and hopes to cash in not on the interest, but on the growth of the value of his or her shares. So, it might make sense to wonder whether the p2p lending companies might eventually move into p2p venture capital as well... except that we already have p2p venture capital: it's called the public equities markets. If you actually tried to do that with private companies, you'd quickly run into all sorts of trouble with the SEC, which is pretty strict in terms of regulating how a company goes about raising money in exchange for equity. In fact, there are many who believe that a startup may be toeing the SEC's line simply by saying that it's out raising venture money. So, for a variety of reasons, both regulatory and because public equities markets already are p2p venture capital offerings, it's hard to see there being a huge market for companies to get into offering p2p venture capital.

Filed Under: p2p lending, venture capital

Clean-Tech Bubble? How Cliche

from the here-we-go-again dept

There's no debate that the clean-tech sector has been enjoying a surge of interest from the venture capital community. Wired magazine takes a quick look at some recently released data that shows that clean-tech investments by VC have surged to new heights in 2007. The article notes that clean-tech dollars are closing in on the amount invested in Internet start-ups which, naturally, raises the specter of everyone's favorite B-word: Bubble. Yes, the accelerating rates of VC investment into clean-tech companies might chart something like late-90s VC Internet start-ups. Yes, 2008 may indeed bring some clean-tech "venture flameouts" reminiscent of Webvan and eToys. Overall, though, using the history of the Internet sector as a yardstick (let alone a forecasting tool) for clean-tech is naive. The article does steer away from this analogy to some extent: on the whole, clean-tech companies will be measured the old fashioned way, in revenue dollars rather than in clicks, page views, or eyeballs; clean-tech companies are generally trying to capture pieces of some very large existing pies, rather than define and create new markets for themselves; and clean-tech businesses look more bricks-and-mortar than Internet in terms of infrastructure requirements.

Digging a bit further into the numbers provides some insight into whether or not VC firms are looking at clean-tech as the Internet-boom redux. While clean-tech VC dollars are closing in on the amount invested in Internet start-ups, the number of companies funded with those dollars is much fewer (168 deals over three quarters of 2007 compared to 195 Internet deals in the third quarter of this year alone) and the value of those deals is substantially bigger (upwards of $11MM on average, compared to $5-6MM avg. for Internet companies). The number of new Internet companies getting funded far exceeds new clean-tech businesses, meaning much of the clean-tech money is re-investment in existing companies. In this light it's fair to say that the growth in VC dollars for clean-tech is more indicative of a maturing sector than of a bubble buildings to a burst. A few billion dollars seems to be a reasonable investment toward trillion dollar opportunities. But if I start seeing beige-and-white box vans driving around San Francisco again, and sock puppets on TV, I'll start getting worried.

Filed Under: bubble, cleantech, venture capital

How Not To Improve Your Reputation: Sue A Site That Has A Negative Review Of Your Firm

from the streisand-effect-at-work dept

TheFunded.com is a popular website here in Silicon Valley for venture capitalists and entrepreneurs alike. The site allows entrepreneurs to post comments and ratings about various VC firms and their partners. Considering how big a role a venture capitalist takes in the life of a startup having more information from those who have dealt with them in the past is tremendously valuable. At the same time, venture capitalists rarely get much feedback on how entrepreneurs feel about them, meaning that some can go on treating entrepreneurs terribly for years -- perhaps without realizing it. TheFunded has helped change that dynamic somewhat, both giving entrepreneurs a way to get more information (and share more information) about the VCs they've dealt with and for VCs themselves to get more feedback. Of course, some of the VCs who are criticized aren't happy about it. Most, however, seem to grudgingly accept the constructive feedback (while also begging their portfolio CEOs to write nice things about them). Earlier this month, the sites previously anonymous founder outed himself in a Wired article, making some wonder what the reaction from the VC community would be.

In at least one case, it appears that the reaction is to reach for the lawyers. As VentureBeat notes, Hercules Technology Growth Capital, which is actually a pretty large venture debt firm (more than venture capital), has sent a cease and desist letter to theFunded after a negative review of Hercules appeared on the site. This seems like a bad idea for a huge number of reasons -- all of which Hercules and its lawyers probably should have realized before sending the C&D. First off, as it seems we have to repeat almost weekly around here, section 230 of the Communications Decency Act very, very clearly states that a site is not liable for content its users post, and any law firm should know that. Second, and more importantly, as you would expect, the Streisand Effect kicks in. Prior to this, not a whole lot of people would see the review of Hercules. Now, however, many, many, many more entrepreneurs will not only see and remember the negative review, they'll see how Hercules responded to it, which may be even more damaging to the firm's reputation.

Filed Under: defamation, liability, reviews, section 230, venture capital
Companies: hercules, thefunded

Musicians Don't Need Venture Capitalists Any More

from the do-it-yourself dept

I just heard Tyler Cowen, one of my favorite econobloggers, on the public radio program On the Media discussing Radiohead's name-your-own-price model for its latest album. (The segment starts around 38:20 in this MP3) He makes a number of good points, but I think he overestimates the importance of the recording industry in the coming years. He says: "When you go back to this core function of discovering new music, lending the money to the people who produce that music, taking the chance, and then getting the product out there and publicizing it, the labels offer very important value, and the Internet is not a substitute." In the pre-Internet world, this was a reasonable description of the recording industry's role. Publishing a new album was a risky endeavor because you had to cover the fixed costs of recording the album, pressing several thousand copies, shipping them to retail stores, and undertaking an expensive nationwide promotional campaign. If an album fell short, the label risked losing tens of thousands of dollars.

Filed Under: business models, economics, music, venture capital