The Kickstarter Revolution

Anyone who's run the gauntlet of trying to get funding for a creative project from foundations, or investments from angel investors or venture capitalists, knows how grinding the process can be. Kickstarter was started in April, 2009 as a service that helps writers, artists, musicians, filmmakers and entrepreneurs to get funding for their projects from individuals, rather than from foundations, corporations or professional investors. Kickstarter has two important provisions: Every project has to set a funding target and a deadline. If the project reaches the funding target on or before the deadline date, the project gets funded and the sponsors have to live up to their commitments. If the project doesn't meet the funding target by the deadline date, the funding commitments are canceled and no money changes hands.

When Kickstarter launched, it was far from certain that enough interesting projects would surface to fund, or enough people would provide funding to make it work. However, word spread about the service very quickly. There are no official statistics on the number of projects that have been funded or the number of people who have participated, but hundreds, if not thousands, of projects have been funded in the 18 months that Kickstarter has been operating.

One of the things that makes Kickstarter unique is that sponsors aren't investing in a business--they're buying a product or service. For entrepreneurs, that means that they don't have to give up equity in their company to get funding. There's no problem with securities sales. In addition, the risk to sponsors is dramatically limited, since unpopular projects don't get funded and the sponsors never have to pay.

I've purchased a set of prototyping icons and a tripod mount for my iPhone 4 through Kickstarter. The iPhone 4 tripod mount project is still underway, and it's impressive to see the effort being made by the two developers to manufacture the mounts. Many of the projects submitted to Kickstarter will be one-off efforts, and the artists and entrepreneurs will go off to do other things, but some of the projects will result in long-term businesses and artistic efforts.

Kickstarter is already taking over the role of book publishers by paying author advances and the costs of editing, designing and printing books, record companies by paying musicians' advances for recording, producing and mastering music, and angel investors by paying design and manufacturing costs for hardware, software and services. It represents a true revolution in the way that individuals and businesses can raise money to work on projects that they care deeply about.

There are already a number of other groups following the Kickstarter model, and more are sure to come, especially considering that Kickstarter's transaction partner, Amazon, only works with creators and sponsors with U.S. bank accounts. The Kickstarter model could work very well in Europe, Asia, Africa, South America and Australia--anywhere where some people have creative ideas and others have the money to fund them.

The value of ideas (hint: It's not zero)

I've read a few articles recently that argued that ideas, by themselves, are worthless. According to these writers, it's only when an idea is implemented (e.g., when a startup takes the idea to market) that it has value. In support of their argument, they cite the belief that angels and VCs pay much more attention to the team than to their idea; a great team with a bad idea can find a better idea, but a mediocre team, even with a great idea, is likely to fail.

I disagree with the argument that ideas are worthless. Every business starts with an idea, and if it's a bad one, the company will probably fail unless management recognizes the problem in time AND finds a better idea to implement. A good analogy is between potential and kinetic energy. An idea by itself has potential energy that can be released (converted into kinetic energy) if it's implemented properly. The better the idea, the more potential energy it has.

There are great ideas with tremendous potential that can't be released, because they're ahead of the market or the available technology. That doesn't make them worthless--it just means that they need to be put on the shelf for a while. There are equally great ideas that are implemented by mediocre teams and fail, not because the idea isn't good but because the team implementing it bungled the job. The implementation of the idea was bad, not the idea itself.

As for VCs and angels who believe that if a "great" team has a bad idea, it can successfully pivot and find a better idea, consider that for even the savviest investors, 70% of their investments fail completely, 20% survive but rarely return more than their initial investments, and if they're very lucky, 10% succeed and are either sold for a big profit or go public. In my opinion, it's at least as likely that the "great" team will go from one bad idea to another until it runs out of capital or blows apart.

One other point: The definition of a "great team" is very speculative. Enron had a widely respected management team, right up to the point that it imploded. The top management of the major commercial and investment banks were considered "Wizards of Wall Street", even though they didn't understand the financial instruments that they were buying and selling. We didn't find out how incompetent they were until they nearly dragged the world into a new Depression. It's very difficult to identify the teams that are going to work well before they've actually spent a considerable amount of time working together on the idea that's being funded (not based on their previous experience working together at other companies.)

Therefore, the quality of an idea is at least as important as the team executing it. If you discount the value of ideas, you do so at your peril.

The Primate School of Management

I often think that business students would be better served if they had to take more courses on social sciences--sociology and anthropology. They'd have a better grasp of how businesses actually operate and consumers actually think. Homo Sapiens are primates. We're not computers.

Most economists view humans as rational beings who will always make decisions that are in their best interest. The reality is much more animal-like. Humans make emotional decisions and then rationalize them. There's no better example of this than the automobile industry. If humans truly were rational beings, there would be only a handful of car models available, and people would buy the model with the lowest overall cost that best suits their needs. They'd keep their cars until the exact point that it would cost less to buy a new one than to continue to fix and insure their existing one. But, if that were the case, we'd have no auto industry to speak of.

People buy cars because they like how they look, or they "fit their lifestyle", or they project some attribute of their personality that they have (or wish they had.) There's nothing rational about those decisions; they're driven by emotion. People regularly trade in cars that have years of life left, even if they'd be thousands of dollars ahead by keeping the car rather than trading it in, because they have "new car fever."

If people are that emotional about a simple appliance, a device that enables them to get from Point A to Point B, why do we assume that they make purely rational decisions about their investments? What statistical model validates the concept that when you group thousands or millions of emotionally-based transactions together, they become rational?

Companies are groups of people. They constitute societies with mores and values. There are in-groups and out-groups. And, like people, they act emotionally and then rationalize their decisions. How else do you explain the thousands of bad decisions that are made by companies, large and small, every day? Is it that they don't have "perfect information?" No one does, yet they'll spend millions of dollars trying to get it. How do you justify spending months working on annual business plans that everyone knows will be obsolete before they're completed?

Expecting rational behavior to spontaneously emerge from groups of emotionally-driven individuals is itself irrational. We'd be better off if we assume, and allow for, emotionally-driven decision making, instead of assuming that economic decisions are always rational and then being shocked when we find out that they're not.

What's the real impact of government vs. culture on new businesses?

I was at an entrepreneurial conference in Chicago this weekend. The keynote speaker started off with the requisite witty anecdotes, followed by statistics about the impact of new and small businesses on the U.S. economy. To wrap up, she barreled into an Objectivist rant demanding that government get out of the way of new businesses. She may have thought that her screed was motivational, but it only left myself and most of the people in the room thinking "WTF?".

So, what's the real impact of government on new business formation? Government can stimulate new businesses with R&D tax credits, accelerated depreciation and taxing capital gains at lower rates than regular income. However, tax rates themselves have very little to do with either encouraging or discouraging new businesses. Consider that Chicago's "structural environment" is, in many ways, superior to Silicon Valley: At least as many top universities, excellent infrastructure, significantly lower state and local taxes (a 3% personal income tax vs. 9% in California, for example), and a more lenient, business-oriented regulatory structure. Chicago is physically closer to many more U.S. markets and to Europe, and is only a few hours further away from Asia.

Nevertheless, even with all those advantages, the rate of startup formation in Silicon Valley is one to two orders of magnitude higher than the rate in Chicago. Why? The reason is cultural, not governmental. Silicon Valley has a culture that, for several generations now, has inculcated the belief that it's better to have control over your own destiny than to give control to your employer. If you're happiest when you're getting a regular paycheck with good benefits, you're not likely to try to start your own company, and if you do try, you're likely to fail.

Chicago's culture is far more the norm for U.S. big cities; most people are perfectly happy with regular paychecks and don't have the "fire in their bellies" to go out and change the world, or at least a little piece of it. The problem with that thinking is that the regular paycheck and benefits lifeline is going away. Companies are moving away from permanent employees and toward contractors, temps and outsourcing. As Daniel Pink wrote a number of years ago, we're becoming a "Free Agent Nation."

So, the biggest reason why Chicago doesn't rival Silicon Valley as a startup formation mecca isn't government policies, it's a mindset that believes that if we do a good job for our employers, we'll be taken care of. Until many more people here believe that they can do a better job of looking out for their own best interests than can an employer, Chicago won't become a startup mecca. The speaker at last weekend's conference got a part of the Objectivist pitch right; it's just that the problem isn't government vs. startups, it's dependence on big business to provide support vs. taking responsibility yourself.

Videoconferencing: "Good enough" is good enough

I'm watching seminars put on by Stanford University's MediaX program. The first seminar, on the impact and use of new mobile video technology for news gathering, was technically a little shaky, but informative. The second seminar, on the value of new video technologies in business and education, seems to be more a sales pitch for Cisco's telepresence technology and similar offerings than a real discussion of the value of video. (If you haven't seen Cisco's commercials, their telepresence model uses big screens that allow you to see the participants in both sides of a teleconference in near life-size. Cisco's even bigger telepresence systems, which haven't been featured in television ads, use specially-built rooms and wall-size displays to give the illusion that the participants are all in the same room.)

Cisco-style solutions are very expensive; tens or hundreds of thousands of dollars per site, with major bandwidth requirements. To vendors of these systems, Skype and similar services will never be a good substitute, because you can't see and hear every nuance of every participant. Sometimes the picture freezes. It's not immersive.

The problem with these arguments is that time and time again, high-end, high-quality offerings are rejected in favor of "good enough" solutions. CDs are being replaced by MP3 files that don't have the same sound quality but are far more flexible and less expensive to buy. Consumers eagerly watch video on their computers (or their phones, for that matter) that isn't the equal of what they can see on a HDTV, because they can watch what they want, how, when and where they want.

Teleconferencing works the same way. If I can use Skype or Apple's iChat to pull together an ad hoc videoconference with existing equipment and at little or no cost, do I really need to see if someone in the 23rd row is picking his nose? Just as consumers gravitate toward "good enough", smart businesses and educators will do the same thing.

Pivots: Getting it right the first time

Veoh's bankruptcy and liquidation announcement last week was no surprise for people who had followed the company for years. Veoh raised $70 million dollars in venture funding from mid-2005 to its demise. Its bankruptcy was triggered when the company could neither raise more money nor find an acquirer.

Veoh was somewhat unusual in the online video space, in that it followed the same basic business plan from launch to death (although, as Dan Rayburn pointed out, the elements of that business plan changed like the wind)--an advertising-supported business that aggregated content for consumers. A far more common path for online video startups is to begin as an advertising-supported content aggregator (either user-generated or professionally-produced content), and when that doesn't work, change direction (pivot) and take some portion of their technology--content management, encoding, video players or advertising delivery--and market it to businesses on a "white label" basis. When that plan fails (as it usually does), the company is either sold to an acquirer or shuts down.

An excellent example is Joost, which launched in late 2007 with a blizzard of hype as an advertising-supported content aggregator. It dropped its consumer-oriented services and shifted to offering white-label video distribution services to business in the summer of 2009. After burning through $45 million in outside investment and untold millions more from its founders, it was sold for a few million dollars to November 2009.

One lesson from all this is that pivoting will not necessarily save your business. The Lean Startup and Customer Development movements emphasize agility and quick changes to your business plan over taking the time at the outset to insure that you're targeting a real market opportunity and not a mirage. This works very well early on. However, once you staff up and raise a significant amount of outside investment, it's easy to find yourself trying to make a broken business model work for far too long. By the time you pivot, it's too late. Your investment, technology and user base become an "anchor" that defines the businesses that you can pivot into. In the case of online video, you end up pivoting from quicksand into a desert.

It's essential to take the time upfront to get your product/market fit right, and to insure that you're pursuing a real market and not a mirage. You may have to change direction a lot in the first few months of operation, as you learn more. It's much better to recognize early that you're going in the wrong direction and make changes, than to try to make mid-course corrections to a speeding locomotive. Once you've raised funds, staffed up and built your infrastructure, inertia and ego kick in, and fundamental changes to your direction will become almost impossible.

Thus this warning: Pivot early and often (if you have to), because you probably won't be able to successfully pivot later on.

Speed, not scale

Since the dawn of the Industrial Revolution, businesses have done everything they can to get big. Bigger companies can produce more at lower costs, allowing them to either lower prices and increase demand, or maintain prices and increase profits. More revenues and more profits enable you to get even bigger. To oversee a growing organization, you need more and more layers of management. You also have to do extensive planning and forecasting in order to anticipate the future. And to keep the wheels from flying off, you need detailed policies and procedures to cover just about every possible situation.

This model works fine in large, relatively stable markets, but as soon as the rate of change increases (due to technological or customer demand changes, competitive pressure, the availability of desirable substitutes, or any of a number of other causes), large organizations are unable to respond rapidly. As Nassim Nicholas Taleb demonstrated in his book "The Black Swan", there's no business or economy that's immune to rapid, and sometimes catastrophic, changes. What that means is that the bigger an organization gets, the less able it becomes to withstand sustained change.

Scale certainly still matters in some industries, especially those that require enormous capital investments. However, the value of being small, nimble and able to rapidly adapt to change outweighs the value of size and scale. Thanks largely to the Internet, small players are no longer at a significant cost disadvantage vs. big competitors, and geographic location is no longer essential for success. Speed, not scale, will win the race.

Rewards lead to results

Have you ever wondered why so many companies are so focused on this month's or quarter's sales, while others have better long-term performance and are successful year after year? Why do some companies put so much effort into writing long-term plans that no one reads? The answer is employees do what they're rewarded for and avoid things that will lead to punishment. It sounds Pavlovian, but it explains a lot of behavior that otherwise doesn't make a lot of sense.

Salespeople are usually rewarded based on meeting quarterly and annual quotas. If they miss their quotas, their income will be lower than expected, they won't earn bonuses and they might get fired. Therefore, missing their quotas is to be avoided. On the other hand, they don't want to exceed their quotas by too much, because if they do, their quotas will be increased in the next period and they might have trouble achieving them. Also, if they know that they're going to exceed their quotas and they can have their customers defer purchases to the next quarter, it'll make next quarter's numbers much easier to make. So, even though they might be able to sell more in the current quarter, they don't.

Executives in public companies know that their stock value is based largely on sales, earnings  and profitability growth. It's easier and faster to increase profits by cutting costs than by increasing sales; that's why companies freeze hiring, delay capital expenses and lay off workers at the first sign of a sales downturn. These actions protect earnings and help to maintain stock prices, which means that the executives can preserve their bonuses. Obviously, many cost cuts are necessary and appropriate, but companies often overdo it, making themselves uncompetitive and crippling their ability to respond when the economy recovers. Short-term pain avoidance almost always trumps long-term thinking.

Rewards don't necessarily have to be economic; they can be emotional as well. Many studies show that giving people personal recognition for doing a good job can be even more effective in eliciting a desired behavior than bonuses, especially if the positive recognition is given often and sincerely.

Companies often reward employees for doing the wrong things. For example, some companies reward employees for writing long, detailed plans that are then put on a bookshelf and ignored. The details of the financial forecasts, the number of pages and the length of the accompanying executive presentations are the measurements for whether the plan is good or not, rather than the fact that events may make the plan irrelevant in a few months. Employees get the message that quantity is more highly valued than quality, and that the plan is more important than actual performance.

In short, people do what they're rewarded for. If you're not getting the results you want, first figure out what behavior you're rewarding.

Buzzwords Without the Benefits

The eBook software company that I work for was just merged into a larger software division of the same company. This larger company uses Extreme Programming (XP) primarily as an excuse to put developers into pens. While other companies using XP put two developers into each cubicle or office, at this division, developers sit side-by-side at long tables with no privacy. The developers could just as easily be machine tools.

If the company was really getting benefits from the approach, I'd say that the human cost might be worth it, but they only manage to get one release out a year. Neither time-to-market nor responsiveness benefits from their approach. Developers are moved from project to project in order to meet staffing demands, so it's difficult or impossible for them to build and maintain domain expertise. There seems to be plenty of demand for customer support, so their approach isn't resulting in easier-to-use or higher-quality products.

I'd argue that the only reason that this company has been successful is that it's selling into a very conservative market that changes and adopts new technology very slowly. If they were competing in a more dynamic market, they'd have their heads handed to them.

It's easy to convince yourselves that you're experts in a given field if you're in a market cul-de-sac or technological backwater. An easy way to fall into this trap is to benchmark your operations against your direct competitors--that's what the U.S. automakers did, by comparing themselves against their next-door domestic competitors instead of the best companies around the world. The smart thing to do is to benchmark yourself against other similar, but not necessarily competing, businesses. Identify what they do right and what your direct competitors could learn to use against you.

The Entrepreneurial Challenge

2010 has just begun, and depending on who you talk to, we're either still in the Great Recession, or it recently ended. Either way, there are millions of people in the U.S. and around the world who will remain unemployed or underemployed even after the economy recovers. As a society, we have both a moral and economic imperative to help these people get back on their feet. As a country, the U.S. can't survive with a hollowed-out manufacturing base, and having Wal-Mart or McDonald's as employers of last resort helps no one.

I believe that the end of the Great Recession presents a tremendous opportunity for individuals who want to start their own businesses. For many people, entrepreneurship will represent their best, or even their only, means of getting back on their feet financially. The challenge for those of us who have spent most of their careers in Silicon Valley and other entrepreneurial centers is to bring that startup culture to people who need it.

We've got the tools to spread ideas quickly and inexpensively; we need to use them to encourage new businesses, no matter where they're located. We also need to adapt our philosophy and techniques to the needs of entrepreneurs outside the major technology and business centers. It's far more likely that these new entrepreneurs will start a restaurant than a software company, and very few of them are ever going to have a business that's likely to go public. We need to help them build sustainable, profitable businesses that will allow them to make a good living and support themselves and their families.