On VCs and Products and Services: Another very provisional post

Nic Brisbourne set this particular snowball rolling along, with his comments on one of my recent posts. I’d been talking about a future where increased commoditisation led to there being only one real sustainable differentiator, the customer experience.

One of the things Nic said struck a chord with me. A discordant and jangly one. [And no, that’s not because I’m listening to James Marshall H play Voodoo Child (Slight Return) right now].

Here’s a quote from what Nic has to say:

  • Recently I have been reading a lot about the importance of customer service as a differentiator – Brad puts in this context on the Union Squares blog and JP recently wrote the following:
  • As we move towards realms where more and more things get commoditised, and more quickly at that, it is reasonable to assume that the only aspect of a service offer that differentiates one firm from another is the quality of the customer experience.

  • If this is true it is bad news for venture capital.  Customer service and the customer experience are of course important to get right, but they are more about perspiration than inspiration – and inspiration is where the big money is at.  You wanna be investing in companies that have revolutionary products – like the ones I listed earlier.

Thankfully, Nic doesn’t stop there; he points out that there are many opportunities for innovation that have yet to be exploited, and gives the real-world use of virtual worlds as a good and down-to-earth example [you’re right, I just couldn’t resist describing virtual worlds as down-to-earth :-) ]

But somewhere along the line, the deeper point he makes jarred me into thought.

It’s been 50 years since  the tertiary sector began its explosive growth, so much so that we’ve already had a coupe of services-intensive recessionary cycles. Yet, during all that time, as the VC community we know and love has evolved to what it is today, the reality is that VC investment is still about products.

And now, as we move deeper and deeper into the knowledge economy (often referred to as the quaternary sector, and sometimes even seen as inclusive of the quinary sector, covering pure health, education and welfare services), we could have a problem.

We’re moving into the Because Of Rather than With World, so eloquently described by Doc. Where infrastructure is often built on a Nobody Owns It Everyone Can Use It Anyone Can Improve It world. Where the creativity and innovation of the knowledge worker teams operate on the edge of the core infrastructure. A core infrastructure that used to be a rich vein of gold, but is now a humble spade.
And maybe. just maybe, VCs aren’t prepared for this. Product-based business plans are all about With. You make money With the product. Knowledge-based business plans will all be about Because Of. You make money Because Of the product.

[Doc commented on some of this in a recent Linux Journal post, which you can read here]

Up to now, things have been easy, as Nic describes:

  • Best practice for financing web2.0 style companies has been (for a while now) to:
    • Have an original idea for a new product
    • Quickly launch a rudimentary service
    • Capture feedback as traffic grows to improve the service so creating a virtuous circle (note the winner-takes-all nature of this)
    • Find a way to monetise
  • It is usually only at the third stage of this that money on the venture capital scale is required and companies need less money overall.

There is an argument that suggests that Web 2.0 companies have been creating their own private version of Global Warming, using up more infrastructural resources than they create. Much of the hoopla about Net Neutrality was about some version of this argument.

This is all about perception, the perception that Web 2.0 companies are free-riding on someone else’s infrastructure investment.  And the VC community may well believe that as well, I need to think about it.

If I’m right about this, then one of the unintended consequences of such perception is seen in stupidities such as bad IPR and bad DRM.

Doc and I conversed about this for quite a while in the early summer. How do we fund things that are really Because things? What is the investment model for Because infrastructure?

  • Anyone can see we have a problem
  • Everyone stands to gain if we solve the problem
  • Nobody’s doing anything about it.

We need to solve this. We need to know how to get Because Infrastructure funded. If we don’t do this, we will probably go back to the Dark Ages, where vendor lock-in was common, where everyone paid EAI tax to move information around between prisons, and where, just occasionally, someone succeeded.

We need to solve this. Before Nicholas Carr needs to write another book on the subject.

Any ideas out there?

7 thoughts on “On VCs and Products and Services: Another very provisional post”

  1. Oh, my, this is interesting.

    The VC model prefers product companies because their ideal is something where the product instills such demand that customers put up with crappy service.

    This is of course justified by the focus on gross margins. But you have to wonder how sustainable margins are without service. And without service, negative externalities arise, partially because the absence of service is a commitment to disregard relationships over profit. Over time, these relationships become _managed_ and spirals (an uphill snowball?) into crisis events. Whereupon the larger company’s survival instincts kick in with a new commitment for service.

    The question is when this happens they fall into older models, false new ones (like self-service, which is good in theory, as some information might be difference that makes a difference), or venture into new ones (community service, where differences accrue).

    Unfortunately for a venture startup, the service-profit chain and word of mouth properties (you can’t just claim legendary service, the little stories amount to a big one) take time to effect. And when they do, they command a premium, out of something akin to respect.

    Oh, and to your question, the funding of common infrastructure. Of pooling of risk. There is a need for new models. The promising ones in use you know already, where property is initially and perpetually made common to lower the barrier to contribution. Open Source licenses commoditize, but to the level of an individual.

    But in some cases, the initial contributions need to be high. I actually think the answer here is from within your last industry, and something that people like you and Sean know better than I.

    Think about Collateral Management in credit derivatives. Such a system pools risk and hedges against it by balancing each contribution. Unlike a full-fledged clearinghouse, an investment to cover the whole system isn’t made up front. Each contribution is like an anti for a poker game, letting them snowball. But the difference is the spoils are shared and not stacked towards a house. There is no house.

  2. Maybe it’s not the industry I come from, but the culture. Microdebt?
    Grameen Angels?

    I wonder. Let’s see what Sean has to say.more later.

  3. I wonder if VCs tend to use NPV models on their investment options – models that work best for product- or solution-based businesses, where the supplier can take up a symmetric relationship to demand.
    The quaternary-and-beyond sectors are experience-based businesses, necessarily treating demand as asymmetric, but nevertheless dependent on their enabling platform infrastructures.
    From the point of view of the investment in infrastructure, this would mean using an approach along the lines of real option pricing to consider the value of the range of possible uses for the platform.
    This would require a different kind of understanding of markets, closer to that required in the evaluation of credit risk. So perhaps there is a different kind of VC out there, more focused on investing in organizations of demand than of supply?

  4. “As we move towards realms where more and more things get commoditised, and more quickly at that, it is reasonable to assume that the only aspect of a service offer that differentiates one firm from another is the quality of the customer experience.”

    Sounds like you’ve been hanging out with English Cut customers ;-)

  5. bobby, you have been spending too much time listening to Gordon Gecko! The fundamental rule of investment is that what you get out in more than what you put in; otherwise, you would get a better tax break by giving the money to charity! What surprised me is that yours was the first to voice the ROI concept. Is everyone else out there naive enough to believe that VCs “do their thing” out of a passionate love of innovation? Wake up and smell the coffee! I have yet to meet a VC who did NOT invest in a new endeavor without first having a clear exit strategy! If only those guys had been in control of the funds for our adventures in Iraq …

Let me know what you think

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