[This post originally appeared on here:]

It’s been a fascinating couple of weeks in the token world.  We have Monopoly’s decision to replace the iron with a cat, based on a poll launched on their Facebook page.  Feels like selection bias to me; is anyone surprised that the population of people who are fans of board games on Facebook also like cats?

More germane to my obsession with payments was the announcement that Braintree re-launched Venmo as a cardholder side multi-merchant tokenization system.  I realize that’s a mouthful, but here’s what it means:

  • Braintree provides payment acceptance to many (most?) of the most popular online and mobile merchants, like Uber, Fab, HotelTonight, LevelUp, etc.
  • Because all of these merchants have huge mobile traffic, they encourage users to “vault” (ie, store) their credit card information with them, so when they return they can check out with one click (or in the case of Uber, no clicks.)  In actuality, all of these payment card details are vaulted at Braintree.
  • Braintree has convinced at least some of these merchants to contribute their users, on an opt-in basis, to a consortium, such that if I am an Uber customer, and I show up to HotelTonight for the first time, Braintree recognizes me and asks me if I want to use the credentials I’ve already stored with Uber to check out with HotelTonight.
  • Braintree has 35MM credit cards vaulted … maybe 20% of the adult US population, and probably 100% of the early and mid adopters in this country.
  • The reason this works, from a security perspective, is the data on the device you are using.  Because they fingerprint your phone (or PC), and require a password, they have the classic “something you have” and “something you know” security formulation nailed.  In the mobile use case, they also have fraud sensitive data like location; if anything I think this will be a more secure transaction than a typical e-commerce situation (more on that later.)

In the real world, the concept of a token generally refers to the act of substituting something simple and convenient for something more cumbersome or complicated.  Think of the utility of a subway token in preference to cash, or (as in Monopoly), how much easier it is to move a game piece around a board than your physical self.  In the payments world, tokens have traditionally been used to enhance information security.  Tokenization* is a system where you substitute a proxy set of identifying information for the real payment card data, so that merchants don’t have to handle this sensitive and regulated data and it isn’t exposed more than necessary.  This original logic for tokenization (keeping merchants free from hosting payments data) has been taken to the next level by Braintree … the same idea is now being used to make the payment experience quicker and easier, through their consortium model (“if you’ve paid anywhere else, you can pay here, too.)

The important irony here, which is also true of Square’s tokenization strategy (Square Wallet, where you the Wallet serves as a “token” to mask the underlying payment card credentials), is that the tokens being used are actually more authentic than the underlying “real” identity.  Historically and generally, tokens are nonsense strings of characters, designed to abstract away from and hide the true goodies, your credit card number.  But consider the token that Braintree is using:  the fingerprint of your device plus your location plus a password.  And Square?  They use a picture of your face.  What’s more real, a 16 digit number or a picture of your face?  Remember, the purpose of the payments query that a merchant initiates when you try to pay for something, whether on-line or in-store, is authentication, ie, are you actually you?  This gets done through the inherently flawed mechanism of merely checking that the card that has been presented (or typed in) is actually valid.  What Braintree and Square have done is create self-authenticating tokens in a natively multi-merchant construct, and that is a frigging big deal.

The current retail payments industry rests on what is called the four party payment model.  The four parties in question are:  1)cardholder, 2)cardholder’s bank, 3)merchant and 4)merchant’s processor/bank (known as the merchant acquirer).  When the cardholder swipes their card at a merchant, the card and transaction data flow through the merchant acquirer to the cardholder’s bank, which confirms that the cardholder is authorized to make the transaction.  This structure was invented and is perpetuated by Visa and Mastercard, who serve as the information switches between the four parties.

They’ve never been linked, that I’ve read, but I think it’s more than a coincidence that Visa was founded shortly after the interstate highway system.  Before Visa, non-cash transactions were done using store credit … because most merchants knew most of their customers before the 1950s, you didn’t need elaborate authentication schemes.  After the 1950s, Americans grew far more mobile, and store credit became less practical; hence Visa and Mastercard emerged, to enable transactions between strangers.  If you’ve ever used Square Wallet, you’ll know what I’m talking about here:  it feels like the 1940s.  When your face pops up on the retailer’s point of sales system, and the clerk calls you by name, you are no longer a stranger.  I’ve yet to have the pleasure, but I’m certain that when I show up on OpenTable and am greeted by name and asked if I want to check out with my Uber credentials, I will also feel warmly recognized.

This is horribly threatening for all of the incumbent players in the four party model:  traditional acquirers, issuer and the networks.  Plain vanilla merchant acquirers will struggle to compete with Braintree online and Square offline as their tokenized user bases grow (NB:  Square is actually well behind Braintree on this front and we’ll see how they do; IRL is harder than online.)  The issuers lose their ability to differentiate.  Once tokenized and hidden, any given card product is far more vulnerable to being displaced, as the issuers have already learned from PayPal.  How do you stay “top of wallet” when there is no real wallet?  As for the networks, their demise is harder to articulate.  Visa and Mastercard are fortresses, growing 20% per year like clockwork, despite the law of large numbers.  I will leave it at this:  in a world where everyone is known, there is no need for an omniscient middleman.  That feels like a scary fact for the networks.

*Per usual in these blog posts, I’m sure there is a specific definition of tokenization that I’m getting wrong.

Salesmanship of Fools

Matt Harris —  December 26, 2012 — 7 Comments

I was talking to a fellow VC the other day, who I know but not well, and he was clearly searching for something to compliment me on, and what he come up with was “hey, I really appreciate how you’re not always nice on Twitter.” As I replied “thank you… I think?”, I was actually thinking that my portfolio companies sure I wish I were nicer, and followed the standard tradition of hyping them at every turn. Hopefully most of them went in knowing that salesmanship, in the traditional sense at least, is not my forte.

They should also know that it used to be worse. When we were starting Village Ventures 12 years ago, and particularly in the aftermath of the bubble, I used to have a downright dystopian sales strategy. I would go in to see potential investors and spend the first 20 minutes talking about how horrible the environment was: “You know, I agree, that’s bad news, but what’s worse is this…”. After setting the appropriate nuclear winter tone, I would go into my spiel: “As we’ve discussed, it’s not obvious that anyone will ever make money again, but if anyone were to, it’s not impossible it would be us…”. Then I would get to my big finish: “I’m sure this isn’t a fit for you now, but if we’re both still in business in a year or two, we should circle up and chat again…”.

After months of this, my then partner Bo took me aside and explained how things worked. To paraphrase, he made it clear that while I wasn’t ever going to star in Glengarry Glen Ross, I could get better. First, I needed to understand that being negative is a crutch. It’s easier to look smart when you’re being critical and dour, and so it can be a refuge for the insecure. Second, people not only expect salesmanship, but they actually want to be sold. Investors know that salesmanship is important to success, for VCs and particularly for entrepreneurs, so in a sense investor meetings are not only a test of your strategy, but also a test of how well you can persuade. This coaching was at least incrementally effective and I’m proud to say I’ve gone from horrible to bad over the last decade or so.
This all got me thinking about the different levels of salesmanship, which I think could stand to be better understood. The top rung is probably pretty obvious: to paraphrase Lewis Gersh, the prototypical salesman is one who could not only sell ice to Eskimos, but could sell them Sarah Palin for Governor as well. There is something deeply cynical, though obviously effective and maybe necessary, about this type of sales … it requires no link between reality and what is being claimed.

The other end of the spectrum is where I think I’ve ended up, which is that I can be persuasive if and only if I believe in what I’m selling, and my belief system is pretty well defined and constrained by a normal probability distribution. In other words, I can definitely be wrong, but not on purpose. The middle ground is the area I find most interesting, which are those people who technically only sell things they believe in, but are capable of such wild optimism (when it’s in their self-interest) that they can believe a whole hell of a lot. As such, the distinction between them and the unethical (my view) salesperson is a pretty fine line, when it comes down to it.

I’d like to think that at the core of entrepreneurship lies innovation, but you could make a good case that the actual core is salesmanship and persuasion. As such, I think it’s important for all of us in the field to remember that it’s a multi-round (and increasingly public) game that we play, which has enormous implications for sales philosophy and strategy.  One of my general gripes about entrepreneurs and VCs is the hype machine aspects of it, and i think too many people take comfort that they aren’t actually “lying”, they’re just being optimistic.  Ultimately the choice comes down to either a)sell stuff you don’t truly believe in; b)be ineffective because you don’t feel comfortable selling what you’re working on; or c)only work on projects you truly believe in, so as to be in a position to sell like crazy. I think the answer is obvious.

Square Puck

Matt Harris —  November 24, 2012 — 21 Comments

Replica of first hockey puck ever used (it actually was square-ish)

Square Puck:  sounds dangerous, right?  I think it is.

There’s a famous/trite expression, commonly cited in the venture business, about how you want to skate to where the puck is going, not to where it is right now.  As I watch the payments industry grapple to deal with the phenomenon of Square’s micro-merchant processing business, I’m reminded of this truism, and increasingly convinced that all the incumbents are skating in the wrong direction.  This doesn’t mean that Square will achieve the kind of world domination that their valuation implies, but it does mean that lots of other folks are wasting vast resources and time pursuing the wrong goals.

In just the last week, Bank of America announced a micro-merchant offering, and TSYS bought ProPay, a vertically focused Square clone.  In the past year, we’ve seen a steady drumbeat of product announcements from Verifone, Intuit, PayPal, NCR, WorldPay* and PayAnywhere*, all directly focused on competing with Square’s dongle-based merchant payments service.  Meanwhile, in the investment community, there is a lot of self-satisfied sniggering about Square’s business model, in which it is assumed that given pricing and risk, Square loses money on every swipe.  Their recent move to undercut Starbuck’s already razor thin processing costs, even though they aren’t the low cost provider, reinforces this view … there’s no way that is profitable business for Square.  If Square is entirely dependent on merchant processing revenues, they are not only overvalued, they are in fact worthless … that business will never produce meaningful cash or be strategic to anyone.

But that’s irrelevant, as it is increasingly obvious that the merchant side of Square’s business is somewhere they had to start, but nowhere near where they plan to land.  At the end of the day, Square is a consumer-facing company; that is their DNA, their culture and their IP.  The entire merchant processing effort is a loss leader, a necessary evil on the way to building up sufficient retail coverage to make their mobile app useful to consumers.  It’s not too different from what LevelUp is doing, but Square’s approach, both in terms of pricing and design, is far more elegant and nuanced, probably because they control their own payments infrastructure and LevelUp outsources to Braintree.   All of the incumbent merchant processing and terminal infrastructure players who are freaking out about this and building direct rivals are totally missing the point, and are lunging to compete in a segment that will ultimately have a negative profit pool.

Typically in this blog, and more generally in life, I avoid making explicit recommendations and predictions.  I’ve just been humbled too many times by the world’s unpredictability.  But I’m going to make an exception in this case.

The recommendation is that Verifone should swallow their pride and do a comprehensive business development deal with Square, where they enable their entire existing merchant base to accept Pay With Square in exchange for essentially taking over Square’s merchant processing hardware business.  Given Verifone’s bluster and defensiveness regarding Square, I think this is unlikely, but it would be a master stroke.  Square doesn’t think hardware is strategic and is increasingly just trying to build their merchant base (see:  Starbucks deal) and they are only messing with Verifone as an accidental byproduct of their initial go to market strategy.  Square would do this deal if Verifone could convince them that they would take good care of their customers.

The prediction is that in six to twelve months, the conventional wisdom on Square will have changed to reflect the growing reality that Square isn’t primarily a merchant acquirer, but instead a mobile wallet provider.  Pay With Square, just like Google Wallet, PayPal and the other wallet providers, creates a unified merchant-facing cardholder application, which aggregates the user’s existing payment accounts behind the scenes, and layers on offers and enhanced information.

At that point, someone (probably not Verifone, unfortunately for them; my bet is Heartland or Global Payments, with Chase Paymentech as a long shot) will do the business development deal I describe above and PayPal, Verifone, BAMS,TSYS et al will be left holding their dongles.  The whole merchant processing community will then lurch toward some kind of cardholder side functionality, directly or through partnerships, and an unbelievable amount of time will be wasted essentially recreating the current Visa/MC merchant-issuer network in a Balkanized and therefore useless way.  Discover will get bought by Google for $35B and Amex stock will go up 30%.

Unfortunately, by that point, the puck will have moved again, and Square will have abandoned the mobile wallet play in favor of their actual ultimate goal, which is to become a new tender type, disintermediating payment cards altogether.  He shoots…he scores!

*For the record, I think WorldPay and PayAnywhere, with their focus on the SMB segment vs. the true micro-merchant segment, have it right.  NB:  my firm is an investor in WorldPay.

Jamie Dimon

JP Morgan








It’s a hard time to be a banker.

I’ve had this post in my draft folder for a long time, held back from finishing and posting it by the concern that, at least until now, it didn’t seem all that hard to be Jamie Dimon (America’s Banker ™), and he certainly didn’t seem to need a defense.  Alas, no longer.  The final bastion of respectability and prescience in the banking industry has been resoundingly toppled, and we can now look upon the rout in retrospect and try to glean some lessons.

My conclusion is that the dystopian epic that is the story of late 20th century/early 21st century banking is, at heart, about a group of people asked to do the impossible.  For reasons I will articulate below, a catalog of constraints and ill winds conspired to create an unbridgeable gulf between what was asked of them and what they could conceivably achieve with the resources available.  Of course, the story is also filled with knaves and opportunists, and probably everyone involved made more money than was reasonable, but in my experience most of the actors were principled, working hard and trying to do the right thing.  Jamie Dimon serves us well as an example here.  His cardinal sin was not about risk-taking, greed or arrogance, it was his (basically virtuous) ambition to make JP Morgan an important, innovative and growthful company.  I believe strongly that those adjectives are not what should be sought by the CEO of a modern bank, and men like Dimon should find other lines of work.  All of the industry analysts exhorting our current banking leaders to “Do Better” should be change their tune to simply “Do Less.”

About 10 years ago, I decided to focus my investing career on financial services companies.  At the time, this was a bizarre choice for an early stage venture capitalist; I don’t think anyone else in the industry was similarly exclusively focused, and only around 2% of the VC dollars went into the sector.  I had a number of reasons for the choice, which I won’t go into in detail, but one of the most significant was my view that the increasingly radical levels of bank consolidation left the industry vulnerable to entrepreneurial competition.  As I thought about the industry, there were three key segments:  payments, lending and capital markets.  In each, the banks had one or several exposed flanks.  I wasn’t smart enough to predict the financial crisis, but frankly should have been.  It was evident from what I was seeing that the cracks in the dam would turn into deep fissures, in each one of those segments.

It may seem comical to those outside financial services, but there is in fact a robust industry that has grown up around the idea of banking innovation.  You could attend a conference every week of the year on the topic, and fill your non-conference hours reading newsletters and blog posts about it.  Most of what the pundits think the banks should be innovating around is payments, which is basically the act of moving money from point A to point B.  The problem with this idea is that a payment mechanism consists of two things:  a technology architecture and a set of rules.  The technology part is probably obvious, but the rules part is important and distinctive.  Payments is an eco-system business, and the rules define the roles played by all the coordinated but independent parties.  By definition, an innovative payment mechanism, one which represents an advance from what exists, involves an exotic and novel technology or a new set of rules — or both.  For a variety of reasons, most notably the fact that their systems are a patchwork quilt of archaic, mainframe based architectures cobbled together from the dozens of acquisitions behind each of our large banks, banks are not good at technology innovation [one caveat here:  some banks are very good at trading technology, more on that later.]  They have to spend nearly all of their time, energy and resources on vital functions like uptime and security, and that leaves very little for the kind of playful tinkering that underlies most breakthroughs.

Banks are even worse at evolving new rules.  There are three ways to make new rules, two of which don’t work.  The first is to get all parties to agree:  FAIL.  The second is for a small but powerful cohort to band together and try to exert their will on the others:  also FAIL, at least in banking, where despite the consolidation there are still over 8,000 banks in the country, and as many credit unions.  The third way is for a renegade establishment to break the existing rules and keep moving fast enough that they get to critical mass before the rule enforcers notice and can do anything about it.  Banks are not good at breaking rules, and are really not good at moving fast and avoiding regulators.  This is why payment innovation happens by companies like PayPal, Venmo, Dwolla, Zipmark, Simple and Stripe.  Is everything they are doing strictly by the book?  Not even close.  Will some of them achieve escape velocity before they get shut down?  Yes.  [Am I engaging in the pernicious blogger habit of asking and answering questions?  Yes I am.  Will I do it again later in this piece?  Yes, indeed, I will.]

So in the payments world, banks face critical shortcomings as it relates to innovating.  You would think that would be less true when it comes to lending.  After all, that is what banks were set up to do in the first place:  take in deposits from savers, and turn them into loans for borrowers, making money on the spread in between.  To a certain extent, this is still their core mission and they do it well.  There are four key dimensions of competition in lending:  cost of capital, credit losses, cost of customer acquisition and operating expenses.  For a plain vanilla consumer loan, say a mortgage, it’s very hard to beat banks.  They pay depositors roughly nothing (very low cost of capital); in ordinary course the FICO or consumer credit score is highly predictive (controlled credit losses); they benefit from large branch networks and high brand recognition (lowering customer acquisition, though online lead gen models have reduced their advantage here); and they run large, systematized factories for processing these loans (low operating costs).  But the dirty secret is that there isn’t a lot of money to be made in these commoditized categories, and every once in a while there is a crisis and you lose your shirt.  Banks need higher yielding assets, which come in the form of higher interest consumer loans, or business loans of all types.

Not coincidentally, if you canvas the fast growing world of alternative credit now, you will find largely two types of new entrants:  high rate consumer lenders (Wonga, Zestcash, Think Finance, Global Analytics, etc) and business lenders (Kabbage, The Receivables Exchange, Capital Access Network, On Deck Capital, etc.)  The entrepreneurs are, logically, going where the yield is, and where the banks aren’t (there’s a Jesse James joke to be made there somewhere, but I can’t quite sort it out.)  Banks are structurally disadvantaged from entering new areas of lending because the regulators force them to take capital charges against loan types that aren’t tried and true.  This negates their cost of capital advantage.  By definition, these loan types have short histories in terms of credit performance, and are only vaguely related to existing underwriting strategies, which takes away their credit loss advantage.  They probably still have a customer acquisition advantage, but their brands work against them in the consumer categories as they are incredibly skittish about being involved with anything high rate.  Finally, while they can be low cost where they have massive scale, at low levels of scale they are horrifically high cost, given average wages and the tendency of highly regulated entities to constantly invent new “i”s to dot and “t”s to cross.

Given the structural disadvantages that face banks when they attempt to innovate in payments and lending, two areas that should be their bread and butter, is it so surprising that they pushed hard to end Glass Steagall and double down on their capital markets businesses?  I have this image of a bunch of men in grey (possibly brown) suits, sitting around a board meeting in the mid 1990s, post that credit crisis.  One of them stands up in the front of the room and says, “Right, then.  We’re facing stiff competition in all of our high margin payments business and we don’t know how to compete.  We just got our hats handed to us in mortgage, and all we can do on the lending side is pile the consumer card debt higher and deeper; we’ll do that, but it’ll only go so far.  We pushed hard into international, but lost our shirts in Latin America.  The way I see it, we can either admit defeat and become the financial equivalents of public utilities, or we can try to be like Goldman Sachs.  What’s it going to be boys?  ConEd, or the Concorde?”  In my mind, the motion to hire the lobbyists was passed unanimously and drinks were served before 5pm.

But there I go, demonizing bankers, which I promised not to do.  In fact, my image is flawed.  The meetings that caused the problems weren’t backroom meetings like that, they were shareholder meetings, way out in the open.  Bank CEOs were being pressured to grow earnings at 10%+/year, when in fact they should be expected to grow as a function of inflation and population.  Under that pressure, they behaved like human beings, which is to say they looked for ways to do the impossible.  The impossible, as it relates to the third core business of banks, is to prudently grow earnings quickly in a capital markets business.

Let’s look at this most recent JPM debacle as an example of the vise these guys are in.  First, you have to realize that these losses ($2-6B, depending on who you ask [my bet would be on or under the low end]) aren’t from one of their trading desks, which are either oriented towards taking positions to make money on them, or taking positions to facilitate a trade for a client.  The losses took place in a hedging operation, set up to manage and mitigate risk originating from other parts of the business.  There are those who claim that through mission creep, this group ended up making speculative bets way beyond their original brief.  I would submit it’s hard to know that one way or another, and that’s just the beginning of the list of things we don’t know.  We don’t know what the 1, 3 and 5 year P&L of this group looks like.  We don’t know how much profit was generated from the activities that these trades were meant to hedge against.  We still don’t know the ultimate disposition of these trades, much less what that would have looked like if JPM hadn’t been forced by the regulators to go public with their positions and forcibly unwind them.

The answers to all of these could be such that reasonable people would look upon these positions, in the context of the track record of the group and the broader business objectives, and say this was bad execution at worst, and a missed putt at the end of a great round at best.  What we do know is that even at the high end of the contemplated range, it represents less than a 5% hit to equity, and less than 30% of JPM’s annual profits in any of the last 3 years.  Bad news?  Surely.  Punishable by firing squad?  Not in my book.  But here’s the best part:  Predictable?  100%.  What is clear, beyond a shadow of a doubt, is that in capital markets (eerily like in payments or lending), the party that is less regulated is the party who will win.  The story of this bad JPM trade is one of the unregulated hedge fund wolves stalking and slaughtering a sheep wearing an electric fence shock collar.  Not a fair fight, and expecting that JPM will be a winner in similar fights in the future is laughable.

The good news, for bankers, is that there is a way forward.  There is a role, or a set of roles, for banks in all of these business that may not be exciting, high growth or particularly sexy, but can be high margin and massively defensible.  Banks should a)manage regulation and compliance; b)manage security/fraud/identity and c)steward depositor capital into risk managed pools.  Each of these roles demands a separate blog post, but suffice it to say that each is a critical infrastructure layer across the core segments of banking, and banks are uniquely situated, in terms of current regulation, technology assets, brand identity and culture, to own each layer.  By focusing on these roles and not trying to compete with nimbler foes, banks could massively reduce overhead, value at risk and operational complexity.  The banks themselves, and the bankers who work there, would go back to being perceived as pillars of the community, literally supporting the entire ecosystem of commerce.  Not entirely incidentally (at least not for me), a thousand or more entrepreneurial flowers would bloom, as businesses sprung up around the banks, fulfilling the customer facing and innovation functions that so desperately need to be filled.  I predict that companies like American Express (great at payments & brand), Capital One (great at marketing & credit risk) and Goldman Sachs (great at trading technology) would “de-bank”, and choose to partner with Citi, BofA, JPM and others, who would shed many non-core businesses.  This restructuring of the financial sector would put the US back on the path to being the global leader in this area, as well as de-risking the global economy.

And as for Jamie Dimon?  He should call me.  We can do something exciting together.  Definitely not a bank.

Job Creationism

Matt Harris —  December 15, 2011 — 5 Comments

I started my investing career doing leveraged buy-out deals at Bain Capital, working directly for Mitt Romney and his then small group of partners.  I left in 1997 to start my own venture capital firm, and part of my rationale was that I wanted to spend time creating jobs.

In the 14 years since then, I have learned many things.  Perhaps the first thing I learned is that 24 year old people shouldn’t start their own venture firms, but that’s another story.  One of the most important things I learned is that “creating jobs” is an extremely fraught concept.  As the scrutiny of Mitt’s career at Bain Capital begins to intensify, I’m reminded of my initial, naive take on this issue, and how far my thinking has come since then.  It seemed like the kind of unpopular topic that I should write a blog post about.

For the first 3 years of my venture career, until the spring of 2000, I did indeed “create jobs” right, left and center.  All of my companies were hiring anyone who had a pulse.  Fortunately, I was lucky enough to exit many of those investments before the music stopped, but by the summer of 2000, it was clear that all of us in the venture industry had created a few too many jobs, frankly.  I then spent much of the next 18 months uncreating jobs.  One of my CEOs at that time took to keeping a bottle of Jack Daniels in his desk, and at the end of each day of downsizing, we would grimly commiserate.  Bad times.

It’s actually a little strange that I was so intimately involved in all of those terminations.  Today, I probably wouldn’t be involved in firing anyone other than a CEO (god forbid) or a member of her senior staff, and then only if she wanted me there for support.  10 years ago I did more seed stage investing, and as such was more involved in the day to day details of my companies.  Even having said that, however, it still feels pretty self-aggrandizing to claim credit for “creating” any jobs.  I played a role in the maintenance of a healthy (or, a rational observer might claim, pathologically over-funded) early stage equity ecosystem, and I did my best to lend a helping hand as well.  But creating jobs?  I’m pretty sure the entrepreneurs did that, not the funders.

On a slightly more meta level, I have serious concerns about even the most rock star entrepreneur’s claim to job creation, on a net basis.  Let’s look at the newspaper industry (just in case I haven’t depressed you enough already.)  In 1990, the industry employed 460,000 people.  Today it employs 250,000, and is projected to shrink to 180,000.  The two companies who sucked all of the profits out of that business, Google and Craigslist, collectively employ about 25,000 people (Craigslist makes up 30 of that number.  Not a typo.)  So, did the heroes who founded and funded Google and Craigslist create 25,000 jobs, or did they destroy a quarter million jobs?

My point is this:  it’s all capitalism.  Bain Capital is a powerful motor in the capitalist machine, Village Ventures is a much smaller motor, but it’s the same machine.  It’s a big system that produces wealth for society in highly differential doses, and you either believe in it or you don’t.  Companies are naturally selected, if you will, through a process of vigorous competition, and there are definitely winners and losers.  You might even say that it comes down to the survival of the fittest.

I don’t side with the job creationists; I’m with Darwin on this one.

The End is Near (ish)

Matt Harris —  October 6, 2011 — Leave a comment


There is an article making the rounds (link:  here) forecasting a drought in late stage fundraising coming soon:  “When? Perhaps as early as three months from now. Surely no later than six.”  As I’ve have written before, I’m always impressed, but somewhat bemused, when people have sufficient confidence in their forecasts to use words like “surely”.  In this case, I don’t vehemently disagree with the author’s conclusion, but I disagree with his level of conviction.  This post lays out some reasons why he may be wrong … to be clear, they aren’t reasons why he IS wrong; I have no idea if he’s wrong or right.  I’m just pretty sure he’s wrong to be so certain that he’s right.

One of the critical underpinnings of his argument is the data suggesting that venture capital investing is outpacing fundraising, ie, that VCs are investing more than they are raising, and that therefore their coffers will run dry soon.  I think this misses a few fundamental dynamics at work.  The first is that late stage venture capital investing is no longer just a game for venture capitalists.  If you look at the largest deals of Q2 2011, you find these names:  General Atlantic, Tiger Global, Goldman Sachs, Credit Suisse, Great Hill Private Equity, JP Morgan and Harbourvest.  I guarantee that none of those firms’ prodigious fundraising success is included in the venture capital fundraising totals, and yet they took leadership roles in financings totaling over $1B in the second quarter alone.  This list doesn’t include the increasingly active corporate players like Google Ventures, Visa, SK Telecom and J&J, to name but a few; 10% of the dollars invested in the industry in Q1 2011 came from corporates, the most since 2001.  It also doesn’t include the mutual fund companies like T. Rowe Price, international players like DST or the other non-VCs who are investing through Second Market and Sharespost.  Based on the high and increasing activity levels of this long list of investors whose activities are showing up in the “dollars invested” category, but not the “dollars raised” category, I’d be shocked and worried if there wasn’t the gap that the author is so concerned about.

The other primary point is that the stock market is looking shaky, and that therefore, before too long, venture fundraisings will follow:  “Another worrisome omen is that venture funding tends to lag behind stock market moves by a quarter or two.”  The market bottom during the (first) credit crisis was Q1 2009, so I went and looked at what the large financings were in Q3 2009, to see if this lag did indeed affect investor psychology.  I would say, not so much.  In Q3 2009, Twitter, at that time pre-revenue, raised $100MM at a $1B valuation.  In addition, two companies that ultimately went bust raised $350MM in aggregate:  Solyndra and Canopy.  If that’s the kind of incisive due diligence that we should anticipate in Q1 2012, I’m not sure entrepreneurs should be too nervous.

And so, my urgent message to entrepreneurs is this:  the end is nigh!  Unless it’s not.  Run your company sensibly, raise money prudently, focus on hiring great people and delighting your customers, and read fewer hysterical blog posts.

Tear Down This Paywall

Matt Harris —  September 8, 2011 — Leave a comment

I was speaking with a friend of mine, an incredibly talented New York Times reporter and great friend, about the NYT paywall recently. When she asked me if I paid, I responded with an indignant “no”, and proceeded to rail against the policy and the whole economic model of putting barriers between journalists and the readers who are interested in their work. When she followed up with a bunch of logical questions about why it was that I felt entitled to the content for free, etc, I ultimately admitted that I was a paper subscriber, and as such wouldn’t have to pay more for the web version. It became clear to both of us that my indignation wasn’t about the money, but rather a steaming sense of frustration that the whole paywall strategy was just wrong, and would hasten the demise of my beloved New York Times. After all, even if I hadn’t been a subscriber, I would still get to read the articles I was interested in if I got to them via Twitter or Facebook shared links. What the NYT had given up was the idea that they were the paper of record for me, my starting point online and a part of my identity; now, they were just one source among many, found through links curated by the folks I follow and respect.

I recently had a similar experience with, where I went to see an article about a state fair who had pioneered “fried bubble gum” (true story). The site launched a video ad at me and crashed my browser (the latest version of Firefox). I fired off a snarling, churlish tweet about how old media just couldn’t get out of its own way. What is interesting about these two anecdotes? First, that potentially I need some anger management therapy, but enough about me. What’s actually interesting is that someone like me, an avid consumer of media, in fact, I would even say someone who loves media, is so disgusted and annoyed by media’s efforts to make enough money to survive that I’ve aggressively turned away from what they are doing online. Someone who should be on the barricades fighting to defend the traditional media outlets is among the first of the rats to flee the sinking ship.

I guess it’s incumbent on me to propose an alternative, if I’m so certain that forcing people to pay or using interruptive advertising is the wrong answer. I’m not a media theorist, but it’s clear to me that I’m reacting against the thing that’s consistent about those two methods, which is that both will have the effect of reducing readership. The only media strategy that feels right to me is one that drives as much readership as possible. Given the low barrier to entry, there will always be free competition, and as a result even minor impediments to readership will have a significant impact. It could be that we’re talking about the equivalent of the buggy whip industry, and that attempts to restore it to previous levels of profitability are in vain. Maybe quality journalism ends up being supported by donations, like pro publica. But I hope not, and in the spirit of trying to help rather than just criticize, I have a couple of ideas:

Let’s think about what the New York Times (or ABC News, or NPR) produces. Quality journalism, yes. But perhaps even more importantly, the Times produces famous journalists and opinion leaders. It may not be as profitable as it was, but it is still the most valuable imprimatur in the news industry, and an incredibly powerful platform for a journalist to build a name. Does Tom Friedman help the Times? At this point, for sure. But he wouldn’t be Tom Friedman without more than a decade of prime space on the Op-Ed page. I’d be interested to know what the annual revenues of the Tom Friedman Corporation are now, and it’s disappointing that the New York Times doesn’t get any piece of that, having played a major role in creating the phenomena. Why aren’t they his publisher and speaking bureau? The Times could be the most powerful talent agency on earth, with its own factory for creating talent.

I agree that it’s not entirely crazy to charge for content. What is crazy is to put a “wall” up … walls keep people out. Throughout the media industry, the trend has been to lower up-front payments and make money on usage. Think of the gaming industry … most of the truly successful games are free, and make money from selling virtual goods. What can the New York Times learn from Zynga? Let people in the front door, let them share with their friends and then charge the most devoted users (over time) to access elements of the service that help them enjoy it more. Would people pay for access to and interaction with the journalists? Would they pay to attend events, or for additional photographs, or additional copy on particular topics that happened to be cut from the paper? Would they pay to get certain stories or sections early? I don’t know, but I’m certain the Times won’t ever find out by keeping people off their site in droves.

As I said, I’m not a media theorist (I’m not even a media investor). I’m sure these ideas are specifically wrong, and maybe even broadly misguided. But I remain convinced that raising the price of something, through charging directly or making access more annoying, when that something is perceived as more and more broadly available, is the road to ruin.

[This blog post was deeply informed by conversations with Jonathan Glick, at whose feet I have learned more about the media industry than is probably good for me. Having said that, if I got anything wrong here, the blame is all mine.]

I was on a call with a senior guy at one of my portfolio companies recently, and asked him what the background noise was. He explained that he was at a “Daily Deal” conference. Of course I replied “WTF?”, and he explained that he was one of 500 attendees at the conference, and that it was one of 4 or 5 conferences entirely focused on the Daily Deal phenomena that were taking place this year. Thankfully, he was there as a vendor and not a YADDO (Yet Another Daily Deal Outfit).

If you’ve ever sat down and tried to calculate the lifetime value of a customer against your acquisition cost (and if you haven’t, you should), you will recall that the single most impactful cell in the spreadsheet is the assumption about how many times the customer buys (or, if it’s a service, how long they stay loyal). In the academic literature, and among the consulting firms that study these matters, it is a settled issue: loyal customers generate well over 100% of the profits of almost all businesses.

A long time ago, when I was doing some work in the telecom field, I recall pawing through vast reams of customer data to evaluate the different profitability profiles of different customer segments. Most of our conclusions were nuanced, subtle and open to refutation; the only one that was blindingly obvious was that customers acquired through promotional marketing techniques didn’t stick around long, and therefore were unprofitable. This led to a different kind of segmentation, what you might call behavioral segmentation. In other words, we found that people divided into two buckets, Loyalists and Switchers. There were all types of Loyalists, some who stayed because of inertia, some who were brand ambassadors and truly loved the company, etc, but there was only one kind of Switcher: the bad kind. Bear in mind that this was a telecom company, one of the only types of vendors for whom promotional marketing even stands a chance of working, in that the recurring nature of the service and the high switching costs should create at least passive loyalty. Imagine this math for a pizza place in a large urban area … a disaster.

There have been many critics of the daily deal model, who focus on how unprofitable the initial transaction is for the merchant. If we go back to our lifetime value spreadsheet, that critique gets at the cost of customer acquisition cell, which I will agree is important. Far more important to me, however, is the likelihood (or inevitability) that the customers acquired in this method will have low levels of loyalty, and will readily switch to competitors when the next deal shows up. Groupon’s mobile app “Groupon Now” is the apotheosis of this … by using it, the consumer is assured to get a deep discount on anything they purchase, thereby guaranteeing that they will never be a profitable customer for any merchant, ever again.

Another of the critiques of the daily deal model is the opacity of it, on the part of the retailer. The customer doesn’t even present a payment card, just a piece of paper, so the retailer gets little or often zero data about them. I would submit, however, that they get the most important piece of data they need, which is that the person is inherently a Switcher, or (more likely) has been trained to be a Switcher by Groupon, Living Social, etc. They’ve just walked into the establishment with a sign on their forehead reading “Unprofitable”. It’s kind of like the attractive young assistant who has an affair with his boss, eventually convincing her to leave her husband and marry him, only to be surprised a few short years later when she turns around and leaves him for another man. By cheating on her husband with you, didn’t she tell you all you needed to about her tendencies? Groupon merchants are “stealing” customers away from their competitors, don’t they think that the irrefutable infidelity of those customers will reoccur?

Let’s take this to its logical extreme. Imagine everyone in the US armed with a smart phone and some daily deal company’s version of Groupon Now. Every purchase we make takes into account which nearby vendor (or online vendor, depending on the category) is running the deepest discount. Retailers have margins ranging from 2% (grocery) to 19% (restaurants). If you slice even 25% off the average bill (vs. the 75% they give up now to Groupon), they are all dead. If you slice 25% off 25% of the customer bills, for a 6-7% hit to margins, most are dead and all are hurting. The only answer: raise prices across the board to compensate for the impact of the Switchers. This further drives the average consumer into the arms of the discounters, in a cannibalization race to the bottom, creating a Nation of Switchers.

This is not going to happen. Retailers know the value of loyalty, and will team up with companies like Foursquare and others to focus on rewarding loyalty, not switching. In two years, we will look back on those Daily Deal conferences with a rueful smile.


Matt Harris —  May 31, 2011 — 1 Comment

It never ceases to amaze me how frequently startups manage to beat large companies. I was in a big bank the other day, and couldn’t help but be impressed by the resources they had at their command. They have a massive customer base, huge profits, thousands of people and a well known brand. They could, if they wanted to, build a hundred versions of what, for example, our company BankSimple is building, test each of them on a separate population of existing customers and then spend $100MM to launch the best version internationally across all of their channels (branch, TV, direct mail, online, mobile, etc). If it failed, it would be a non-event; if they saw any sign of uptake, they could pour the gas on to that channel and that segment and build the momentum from there.

I don’t say this to pick on BankSimple. (In fact, quite the opposite, because those guys are going to light the world on fire this fall with their product, and I expect barely a whimper from the incumbents.) Most venture-backed companies these days create advantage more through execution than through intellectual property. They create equity value as much or more through inspired design than revolutionary technology. BankSimple falls into that category, and they are hardly alone. The phenomena does beg the question, though, of how and why big companies let this happen.

I have a theory, and it revolves around intentionality. Big companies have habits; they basically have to. Massive scale requires some degree of standardization, which engenders rules and regulations, which ultimately groove into immutable habits … habits of action and habits of the mind. Big companies do things without thinking of them; that’s just the way they do things.

Young companies do everything intentionally, not least because in many cases they are doing things for the first time. They may not (and I believe should not) step carefully, but they step mindfully. The logo is as it is, the brand is what it is, the office layout is what it is, all of the elements of the business are what they are because a small group of people deliberately intended them to be so … not because of inertia, or policy or precedent. Again, they may be wrong, or require changing, or grow outdated, but they are almost never casual and almost always done with great care.

If you run your business with intentionality, and add to that a fetish for measurement and a willingness to break glass and change things quickly that aren’t working, you have a massive advantage over your incumbent competition.

As Balzac once said, “Behind every great fortune lies a great crime.” In the past few weeks, we have been treated to scandalous-if-true stories about the founding of Facebook and Twitter. Allegedly, Facebook was founded by the guy who stole the idea from a set of Olympian twins, ripped off a wood-chip dealing fraudster for his first $2k of investment and then screwed the college buddy who provided him with additional growth capital. Twitter was the bastard child of a devious founder, who convinced his early investors that it was worthless so he could look like a hero for buying them back at cost, only then to reveal the true glory of the product and, oddly, not even let most of them invest back in later when they tried their damndest to do so. Oh, and he also fired the real founder and, in an Orwellian turn, pretends the guy never existed in press interviews.

Now, I have no idea if these stories are even partially true. Frankly, I don’t care, and am pretty sure anyone who isn’t actually involved shouldn’t care much either, beyond gossip value (though perhaps “gossip value” is an oxymoron). There will be those who insist that the veracity of these claims goes directly to the moral fiber of the founders, and hence perhaps the culture of these companies, and that therefore we all have to know the truth. I think that take is bullshit, and that’s the thrust of this post.

If I had to pick one adjective that describes all radically successful founders, it would be this: transgressive. That trait is what it takes to start a company that attempts to redefine an industry, or, like Facebook, redefine large parts of society. It is not a polite thing to do. It is audacious, disruptive and preposterous on the face of it. Founders have to be persistent (bullheaded), persuasive (flexible with the truth) and visionary (delusional).

Please don’t take this as a defense of actually criminal, or even unethical, behavior. We would never work with a founder who was guilty of what we considered an actual ethical lapse, and surely if all of the allegations regarding Twitter and Facebook are true, those founders have a lot to answer for. When I’m checking references on a founder, I definitely focus about integrity and ethics. It’s incredibly important to me that I can implicitly trust the people I’m in a foxhole with.

Having said that, I’m painfully aware that the world is full of gray areas. So what I always pursue, in addition to positive character references, is 100% alignment. To be honest, if an entrepreneur I really respected came to me and offered to buy me out for 1X my money, and said he was going to carry on with the project without me, I WOULD ALWAYS SAY NO. Always. I don’t get paid to return 1X to my investors, and I never want to sell when one of my founders is buying (though occasionally I do buy when they are selling, for other reasons.) Further, when I’m doing these reference calls, I occasionally hear things that seem bad, but I interpret as good, eg: “John had a bad habit of promising things to the client that didn’t exist, then scrambling like mad to backfill those capabilities”; “When Jill wants something, she can be pretty hard to deal with until she gets what she’s after”; or “Seth asked a lot of his people, and would occasionally burn some of his weaker performers out.”

You should know that all of this comes from a guy who is married to an entrepreneur, and started a firm with one (different people, thank g-d). I am a charter member of the cult of the founder. Of the 10 guys I lived with in college, nearly all have started a company or been on a founding team. Perhaps the best part of my job is getting to spend time with people who do 10 impossible things before breakfast, ie, my portfolio company CEOs. But we should be honest about what it takes to change the world. It takes more than chutzpah. It takes Balzac.