Apple & Beats

imagesHeadline news today in the tech world is all about Apple’s imminent acquisition of Beats for $3.2bn. I really don’t get it and think it’s a weak move.

Beats generates almost all its $1bn in revenues from selling their highly recognizable headphones. But the headphone market is a relatively small one in Apple’s world and it therefore seems unlikely that they are paying up for this side of the business.

I think they see all the value in the Beats brand and how it can be applied to other products with the main one being their fledgling music streaming service. It gives the Apple brand an injection of the cool factor and it gives them a stronger position in the fat growing music streaming market.

Apple’s brand is not as strong as it once was, especially with the younger demographic. Evidence of this can be seen in Samsung’s successful portrayal of the iPhone as the device for older, boring people and their phone being the one of choice for the younger, more creative crowd.

Apple’s iTunes store is also not the force it once was and sales declined in 2013 for the first time; and their move into a streaming service hasn’t taken hold at all.

They see this move as killing two birds with one stone. But here’s why i think they are wrong.

The Beats brand is undoubtedly strong but for me just not sustainable. It has its roots in the young 18-30 yr old market. Not only is this market notoriously fickle but also as the brand moves into older demographics and becomes increasingly mass market, something that will be accelerated by its acquisition by a big corporation, it starts to lose its cool factor.

But also the Beats brand is celebrity driven and, to my mind, therefore difficult to sustain. The company was founded by smart celebrities in the music business. It has been further boosted by lots of celebrities wearing and endorsing the products.

It all seems a bit superficial to me. There are no deeper brand values such as a history of innovation, great product quality or fantastic customer service that are associated with the most valuable brands. The company only started manufacturing its own products around a year ago. And are these celebrities going to be so willing to endorse the products and push the brand now that it’s owned by Apple and they have had their pockets lined with hundreds of millions of dollars? I doubt it.

And then on to the streaming service. You would have though Apple were perfectly placed to transition their iTunes brand into a strong and popular streaming service but it hasn’t happened. They launched iTunes Radio around a year ago but it doesn’t seem to be a big focus for the company and has struggled to build momentum. It seems strange that they haven’t focused more on this service given the growth in the market and it adds further weight to the argument that Apple are great at hardware and software but nowhere near as good in online services – the market that is growing the fastest across the board.

This brings us to Beat Music, their streaming service. The service was launched in January of this year and, while being generally well received especially for its playlists and discovery, is still very small (estimates are at around 100,000 users) in a business that will live and die based on its scale. If a company with more than a hundred billion on its balance sheet really wanted to buy itself into a leadership position in streaming why not buy one of the leaders in Spotify or Pandora – it would still only be a rounding error relative to their huge pile of cash.

So i think this is a weak move by Apple. To my mind it betrays doubts about its brand and also an acceptance that they don’t have what it takes to build their own streaming service into a market leader when you would think they were perfectly positioned to do so. And i don’t think Beats has what it takes to address these areas and prove to be a successful acquisition.

By far the best thing Apple could do for its brand and its future success is to innovate itself like it used to do better then anyone in the world.

Growth

growthI’ve read a couple of pieces recently on growth and they reconfirmed my sense of its importance. One was a piece of research by McKinsey showing how growth trumps all. The other was in the Harvard Business Review talking about the need to invest in high growth firms rather than just small businesses generally.

The McKinsey report studies thousands of software and on-line services companies through their history. It really is fascinating and the conclusion is that growth trumps all. Nothing contributes to the valuation of the businesses like growth. Perhaps the most compelling data point in support of this is that high growth companies (more than 60% CAGR at $100m revenues) offered a 5x greater return to investors as compared to medium growth companies (20-60% CAGR).

The report also breaks down growth into three distinct phases – the prelude, act one and act two making the case for companies needing to know when and how to transition to the next phase.

The HBR piece comes at it from a slightly different angle. They make the case that our obsession with start-ups in terms of a key driver of our economy to be nurtured and supported wherever possible is actually misplaced. It’s a persuasive piece and says that growth companies, as opposed to start-ups, are the key driver of the economy and that they can come from a variety of sources. Start-ups are inherently risky and that only when they reach a point of growth are they really contributing to the economy in any meaningful way. It concludes:

“To use a transportation metaphor: it is futile to jam the on-ramp of our economies with startup traffic without well-paved fast lanes, high powered cars, skilled drivers, good police, and lots of exit opportunities.”

I strongly believe that growth trumps all. I think if you can find a way to grow fast (100% in the early stages and 50-100% once reaching say $50m in revenues) then you are in such a strong position and everything else will follow.

But there are a couple of caveats. You need a business model that delivers high gross margins – ideally over 50%. Growth is kind of neutralized without good margins. This is taken as a given in the software/SaaS world that i work in but not necessarily in other sectors.

You also need to have a costs of acquisition that delivers a return within a sensible period of time. If you are spending on average say $5000 to acquire a customer and your ARPU (average revenue per user/customer) is $1000 per year then that would take more than 7 years to pay back (assuming a 70% gross margin) and that is clearly is far too long. I think you want to see a return within a year at the latest. Anyone can sell $10 bills for $5 but it is not a great business!

Once you have a decent margin and some control over the costs of demand generation then growth has to be the overriding priority. Why would you priorities anything else above it? It has to be – ‘What is my path of least resistance to generate massive growth?’ Nothing else will be so highly valued.

What’s really interesting is to actually think through how this might influence your decision making and priorities? Here are a few of my thoughts:

1. Prioritize growth over profits – this may run counter to the main purpose of most businesses which is to make money but i think it still holds. You need to make sure you don’t run out of money and I would always suggest that a new investment round lasts at least 12-18 months. But beyond that why sacrifice growth to anything else? It is the biggest driver of value. It also give you the momentum in the market and an ever increasing customer base to drive word of mouth and cross sell opportunities.

2. Market segmentation – be disciplined about your market segmentation in terms of relentlessly focusing on the markets that respond best to the current version of your product. To spend time in lower priority markets will slow you down and impact your growth.

3. A repeatable product – try to minimize product customization wherever possible. You need to be disciplined about selling the same version of the product to every customer which means you establish a well worked process and generally create more efficiency and speed in the sales and implementation process.

4. Make growth a central strategic objective of the business – this seems obvious but I have rarely seen it as one of the top strategic goals of a company. To say ‘we are going to grow by more than 75% for each of the next 3 years’ or something along those lines makes everyone focus on this as a priority across the business. Then everyone one every department can break that down in terms of what it means to them. Marketing needs to generate 75% more leads, sales department 75% more sales, client services implement and retain 75% more customers etc. It gets people living and breathing growth, asking themselves ‘how far are we up on the same period last year?’ Growth is definitely the key ingredient to being in control of your destiny and building a really big business.

Transitioning from professional services to a SaaS business

As an investor, I have come across the situation many times where a company is trying to evolve into a SaaS business.

Typically their existing business is some kind of ‘time and materials’ business such as a consulting firm, a marketing agency or a bespoke software developer. The business recognizes a recurring need in the market and this, combined with the megatrend in the tech industry towards the cloud, encourages them to formulate a new strategy to build repeatable SaaS products.

There’s nothing wrong with time and materials businesses. But they are generally not attractive to VC’s and other institutional investors. That’s because they are generally people based and difficult to scale.

So it’s hardly surprising that many of these companies try to move into the more scalable and high potential SaaS market. They are well positioned to understand customer pain points and how to address them. They will also often have some decent cash flow and a good client list with which to build a new business – two things that a start-up usually struggles with in the early stages.

As a result of this there are many of these hybrid companies out there who are moving through this transition with varying degrees of success.  I’m sure you all know of a few.

What I’m interested in is whether hatching a SaaS strategy within a broader business actually helps or hinders it.

Clearly in the early stages it is a big help. The more mature business provides facilities, people, cash and customers that help the new business to hit the ground running.

But my increasing sense is that the more mature business actually holds the new one back after these first few months.  The main reasons for this are that there are conflicts over priorities and use of resources, there is less focus within the company and the two businesses are fundamentally different and require different strategies, people and cultures.

I think businesses hang on to this state for far two long and have a choice to make that should generally be taken earlier than it is. You either separate the businesses entirely and hope that they can both continue to prosper in their own way. This can be complicated in terms of who goes where and gets what but it can be done.

Or you can scale down the older part of the business so it exists only to make the emerging SaaS business more successful.  It becomes the professional services group within the SaaS business helping to showcase the technology, supporting sales efforts, ensuring the service is optimized and strengthening relationships with larger clients. The more mature business is no longer trying to grow as an independent entity but is simply there to help the SaaS business to grow. You will no longer be fulfilling the potential of the older business but have to believe that the combined value will be greater in the long run.

Having come across this situation many times now this is the conclusion I have reached to optimize value but it can be easier said than done with all the time and money we have invested in the legacy business.

Twitter’s Future

Tw_imagesTwitter has dominated the headlines in the tech world for the last couple of days and I felt compelled to join in the conversation.

It seems the biggest talking point has been whether Twitter is overvalued. Whether the company’s performance will live up the lofty valuation or will it prove to be more hype than substance based.

The valuation is certainly lofty by any standards. The company is currently valued at around $30bn. That is a massive 50x current year revenues and around 30x forecast revenues for 2014. We are forced to apply a multiple of revenues because the company is heavily loss making and is expected to be until at least 2015.

To put that in perspective, highflying Facebook is only valued at 15x current year revenues. And Facebook has been profitable for several years.

On a price per user level Twitter also looks expensive. Its 232m active users are valued at around $110 each. Facebook’s 1.2bn active users are worth around $99 each and LinkedIn’s 259m valued at $93.

So is the company going to come crashing back down to earth or prove the doubters wrong?

My feeling is that Twitter’s valuation is frothy right now and this will drop as the hype around the company and the IPO fades. This is already starting to happen with the stock down 8% Friday.

But I also think that Twitter is a sustainable business that will go on to make lots of money and see its share price rise again as it starts to deliver on this. So it may not be worth $30bn right now. But I think it is worth more than it’s IPO value of $18bn and that the company has a really exciting future as one of the internet’s iconic tech brands.

This is why:

Twitter is one of the most mobile friendly applications out there

Twitter’s service works pretty much as well over mobile devices as it does over a PC. This is supported by the fact that 75% of its users access the service from a mobile device today and this will continue to rise. Everybody knows that all the growth in tech is in mobile both in terms of usage and, even more importantly, in terms of its share of digital advertising. Twitter is perfectly placed to take advantage of this.

Twitter’s main product blends in perfectly with its service

Twitter’s main advertising product called ‘promoted tweets’ is entirely native to the overall service. This means that its attempts to drive more revenue are likely to be less disruptive to the user experience and will be more successful as a result.

Twitter is now the world’s de facto platform for live, breaking news

In a world where we increasingly want news and information ‘now,’ Twitter meets this need better than any other platform out there. Major global events like Hurricane Sandy or the Egyptian riots are owned by Twitter because no other platform can get information out there so quickly. This is a unique attribute for Twitter and unique = $’s.

Twitter works very well alongside TV as a second screen

More and more TV companies are starting to see the value of Twitter to further engage fans before, during and after the shows. The more TV’s companies can engage fans the more valuable and sustainable those relationships will be. This is an area set for major growth in the future.

Twitter’s data is a goldmine

Apart from a few licensing deals Twitter has not leveraged the value of its data. Yet the company is sitting on the most amazing amount of live data that covers just about everything that is going on in the world. I think the company will find ways to better exploit the value of this data in the future.

Twitter cannot be unbundled

Unlike Facebook Twitter is not a bundle of services that are at risk of being broken up as newer and more fashionable services become available.  Twitter does one thing and does it well. Its platform makes it possible to share concise information in a way that is truly live, immediate and global.  Twitter doesn’t have to be a big as Facebook. It just needs to focus on what it does best, continue to grow its user base and learn how to monetize it in a way that does not detract too much from the user experience. I believe that it can do this.

So that’s my view and it will be interesting to watch the company grow up over the coming years and whether it lives up to expectations.

Long-term thinker + Short-term doer = Success

The retirement of Steve Ballmer has got me thinking about the balance of a founding team.

Over the 12 years or so since Ballmer took over from Bill Gates as Microsoft’s CEO their share price has decreased by around 40%. The company was worth $400bn in 2000 and today is worth less then $300bn. And this is all during a period of transformational change and growth in the IT industry with companies like Google, Apple and Amazon enjoying fantastic success.

Prior to taking over as CEO Ballmer had been Bill Gates’ right hand man. As far as I know, he was responsible for sales, marketing, client services and pretty much all ‘market facing’ activities. Together they built the most valuable business on the planet.

So what went wrong? My thinking is that a leadership team at the very top of a company needs a ‘visionary’ or long-term thinker working alongside a ‘doer’ who is more operationally minded and just gets shit done.  This is why Gates and Ballmer worked so well together.

As soon as Ballmer took over I believe the writing was on the wall. The on-going operations of the business remained solid and reliable. Ballmer did a great job driving sales and profits from the products they already had. But he completely missed the train on mobile, cloud computing, search and other services. These trends were reshaping the IT industry. But they required a longer-term thinker to understand that. Especially when you have one of the most powerful and profitable product franchises in history to attend to.

This graphic (taken from Benedict Evans blog) nicely captures the huge changes in the PC/devices market that Ballmer failed to appreciate or act on:

Screen Shot 2013-07-20 at 9.23.57 pm

 

I think any company can learn from this. You need to have someone thinking well beyond the day to day operations of the business. This person generally needs to have a technology background and a natural instinct for where the future is heading.  But you also need someone who is making things happen in the short to medium term. Someone who is thinking about individual steps rather than the destination.

And both these people need to be at the highest level of the company where they have a voice at the top table. You want to see a healthy tension between these voices rather than one entirely subservient to the other.

It seems simple but my experience is that the majority of companies do not have this in place and are therefore reducing their chances of success.

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