With Beats Buy, Streaming Music is Now the ESPN of Mobile Hardware Bundles…Is Streaming Video Next?

Apple’s all-but-announced purchase of Beats highlights the inevitable trend in mobile services:  They’ll be bundled with hardware and vendors will compete with tiers of “packages” the same way cable companies do.

Today, ESPN receives affiliate or carriage fees 3X-4X higher than other networks for being part of a programming bundle.  Even the most basic of basic cable offerings has it.  For many providers, it’s the only must-have channel there is.  Looking at Apple’s deal for Beats, it’s clear that for mobile hardware (think:  a set top box that you carry with you), streaming music is now one of the must have channels.

It’s been reported that the Amazon and Google initiatives to offer streaming music services got a jolt as a result of Apple’s plan, which makes sense.  Both want and need the customer interaction to sell adds or gain a further share of purchases that could potentially erode if Apple successfully builds a broad, bundled offering that includes hardware, critical “channels” of rich media services such as music, video, or chat.

However, while Amazon and Google will rightly focus on this deal the one player that hasn’t been mentioned that needs to pay close attention is Netflix.  Simply: today it’s music but tomorrow it’s streaming video.  If Amazon launches its new hardware and bundles a broad new streaming music service combined with a comprehensive video offering all in the Prime package, consumers will be very attracted to the simplicity and value.  Apple and Google will follow.

Being platform independent has been a blessing for Netflix so far and will remain so for the immediate future, but A/A/G are all building out their content libraries and creating differentiated proprietary programming (e.g., Funny or Die, all of the new Amazon shows) and have the reach and distribution platform to siphon off a significant portion of Netflix users over time.  Netflix risks marginalization without the scale that comes either from a multi-media offering or a continuous stream of overwhelmingly compelling programming.  One House of Cards at a time won’t cut it in this new environment.

Over time, providers that are tightly linked to an in-house operating system and/or lustrous hardware will offer proprietary bundled packages of music and video that is billed simply and cleanly.  Theoretically, if not for its current deals with the labels Apple could get pretty close to that today by making iTunes a subscription service.   Similarly, if Amazon had a fleet of smartphones or tablets already proliferated through the market and a deep streaming music offering, they could do the same with Prime.  Add streaming a few local channels and who needs Comcast?  And, who would be willing to pay an extra $9.95/month for Netflix?

If you’re a content creator looking for a predictable revenue stream, an exclusive deal selling programming through a broadly distributed streaming platform will be very compelling.  Netflix has 38 million subscribers growing in fits and starts; Apple on the other hand has an installed base of over 300 million iPhones and growing according to Evercore.  Add another 90+ million in iPads.  So that original Netflix development deal looks a lot different if your new alternative is to debut your latest show within a packaged bundle of hardware, video, music, and other services that is immediately accessible to the entire iTunes eco-system.

I’ve been big believer in Netflix as a transformative company for several years now, but with Apple’s latest purchase and all it portends, they will have some serious soul searching to do.

Yahoo, Let the ! Free From Your Logo!

USA Today reported this morning that Yahoo! is planning to change its logo after 19 years. The hot topic is whether they’ll keep the exclamation point at the end. I’m begging them to drop it, because as soon as they do I’m adding it to my name. Up until now, we’ve all had to muddle by with lesser punctuation marks after our names and logos. Periods, commas, an occasional quotation mark, but nothing as impressive as this: !

I’ve already got the printer preparing the new business cards with a giant one right after my name. No more wimpy ellipses or over used hashtags for me. Once they let it go, it will belong to all of us once again.

The Middle Killer

“Where’s Papa going with that axe?”

E.B. White, Charlotte’s Web

 Something’s crushing the middle.  For the past month, I’ve been talking to people about it and what it means.  But it’s not the middle you’re thinking of.  Not the one politicians pander to.  Not the one that built the US into the envy of the industrialized world and not the class of people that’s emerging with a vengeance in China, India, Brazil, and a dozen other places.

Instead, I’m referring to the middle of the publishing industry, the middle of the movie business, the middle tier of music companies, the middle of the banking industry (over 520 failed banks since January 2008 according to the FDIC), the middle of the ad business, and the middle of the post-secondary education industry.  I’m thinking about several other industries where technological change punched the middle right in the gut, doubled it over and knocked it to its knees.  This is the place where mid-sized firms once thrived but are now disappearing, along with the creative people who previously supported their success.

An offhand conversation started the whole thing.  As I rode on yet another United flight without WiFi or TV screens (how can this still be possible; Virgin America’s had them both for 4 YEARS!)  a stately and erudite book agent in the next seat lamented the situation faeed by many of her authors.  From Denver to Boston, she regaled me with stories of one author after another who once had fine careers writing a new book every other year and selling 8 to 10 thousand copies at a time.  They weren’t rich, but they flourished in a way, with consistent sales, speaking opportunities and reliable income.  No longer.  With online sales eliminating bricks and mortar booksellers, and virtually no margin left in moderately successful hardcover titles, many middle-tier publishers and modest selling authors are being pushed to the poles.

Instead, they face stark choices.  They can go big and try to write blockbuster genre books targeting hot sectors with multimedia potential (e.g., Young Adult) or catalyze themselves into new era writers:  those peripatetic self-publishing promotion machines, relying on Amazon reviews, social media, and their own hustle to build an audience.  Confronted with these choices, many simply cannot transition and have left the literary world and moved to previously safer places like academia.

Unfortunately, established fields like Education are no better off.  The Wall Street Journal recently wrote about Thunderbird’s decision to add a for-profit division.  A historically respected and stable MBA program with an international bent, recent demand has plummeted.  The reasons are straightforward:  Thunderbird is neither ranked in the top tier, nor more operationally efficient and therefore cheaper than its peers.  The school is stuck in the middle.  With a over-sized cost structure, much cheaper alternatives resulting from technological change, a relentlessly weak economy, and no historical reputation to fall back on, prospective students simply decided the ride wasn’t worth the climb.  Thunderbird may be the first but will definitely not be the last to face this fate.

Then there’s the demise of the music business, which has been well-chronicled.  Once iTunes killed CD’s as the form factor of choice, middle-tiered bands with a few good songs, the record companies that supported them, and the retailers who distributed them no longer had a functional business model.  In order to compete for fans, bands either need to already be really big (U2, the Stones), relying on pre-awareness to sell new music and an established fan base to tour at scale, or be really small and nimble, building word of mouth for gigs via social media, YouTube, or, if they’re especially fortunate, by getting on TV.  Would a band like Maroon 5 have never broken out without the support of Adam Levine’s work on The Voice?  Once again, unless you’re lucky or particularly clever, there’s no longer room in the middle.

The ad business is not immune to these technology changes either.  Programmatic ad buying is upsetting the balance of power and creating a new challenge to agencies that lack scale or speed.  As recently as yesterday the Wall Street Journal noted the risk to the middle of the ad industry resulting from the Omnicom/Publicis merger:

“Others say the mid-sized ad firms get stuck in the middle. 

“I think clients will either go to the big ones for the scale or to the small start-ups for fresh creative ideas,” said Richard Pinder, a former CEO of Publicis’ Publicis ad agency, who left the French company in 2011 and now heads up his own small agency.  ”It could raise some issues for the mid-sized players like Havas, Dentsu.  They are neither big nor small in this world.’”

 And the of course there’s my new favorite industry passion, feature films.  The well-known producer Lynda Obst (Sleepless in Seattle, How to Lose a Guy in 10 Days, The Invention of Lying) recently published Sleepless in Hollywood, a sobering look at the hollowing out of the middle tier of the movie business.  As technology killed the DVD market, the basic model of moderately priced movies targeted particularly at adults has been gutted.  Previously, a mid-sized ($20M – $40M) movie could do okay at the box office, but recoup its costs plus a return in video sales.  But now the “Walk and Talk” movies we all used to love must either be made for $3 million or less, attract a gigantic star that will guarantee foreign sales and a strong opening, or become “explode and talk” movies with special effects and a farcical grandiosity that somehow appeals to teenage boys, at least one additional audience quadrant, and attracts complimentary international box office.

For the creatives who provide the lifeblood to these industries, the effects can be devastating.   Just as there will likely to be stranded copywriters as result of the ad industry consolidation, screenwriters have been feeling the pinch.  Thoughtfully chronicled in the wonderful Scriptnotes podcast by John August and Craig Maizen, the number of working writers and their income has remained flat or down for several years now.  Those who haven’t transitioned to tentpole movies or what Obst calls Tadpoles have simply been left flat footed, wallowing up to their hips in beautifully written screenplays that will never get made.

Finally, all this change is having a second order effect in my own business.  Here again, the middle is disappearing.  At its core, what venture investors do is fund creativity.  Whether it’s in salesforce automation, enterprise security, mobile applications, or medical devices, our business exists exclusively to provide fuel to human creative expression.  When the economic foundation of those energies is no longer viable, the creators and the facilitators either need to change—just like the extraordinary list of feature filmmakers who now make TV shows did—or leave the playing field.  The unfortunate fact is that fewer entrepreneurs need fewer VC firms, and the middle tier ones that can’t adapt won’t survive.

The big firms will hold on fine, able to consistently attract capital in all cycles.  Small angel-oriented firms that have manageable infrastructure costs and offer a unique place for individual investors to play in the venture game will carry on.  But its a rough ride for the $100-$250 million funds that don’t have a sugar daddy LP or two.  Those firms are fading away and are unlikely to return.  In my home market of DC, nearly half of the prior decade’s most active firms have either contracted to a fraction of their prior size or shut down entirely.  A firm that was once over-subscribed at $150 million now struggles to hit $50 million in commitments.   So the new normal in the venture industry for the time being will operate the same way as the others mentioned above:  without a middle.

The 7 Deadly Sins of Entrepreneurship

Recently, we had to confront one of the most difficult choices any investor group faces: Replacing a founder.  The decision was extraordinarily tough and got me thinking about the myriad factors that lead to a CEO change, and in particular the benefits of addressing them openly.  If entrepreneurs and investors are going to trust each other, then a peek behind the curtain of why these decisions get made is important. Entrepreneurs deserve to know.

So, I wanted to share a few general thoughts on the entrepreneurial missteps that lead to a change in leadership and then talk specifically about what drove the decision in our portfolio company.  As a heuristic I’ll use a familiar framework: The 7 Deadly Sins.  In the case of our company, only one “sin” was committed, but they all presage change of some form.  I’ll comment on the first six briefly and focus on what ultimately led to our decision.  Finally and importantly, I am not writing about anything that I haven’t discussed openly and at length with the founder.

An editorial comment first.  Most investors prefer never to discuss why this happens or acknowledge their role in it.  Of course, the popular press frequently suggests that firing founders is done quickly and capriciously, something that private equity does with little forethought or remorse.   But in my experience the opposite is true. Every time we’ve had to replace a founder with a professional executive it’s done after months of handwringing, discussion, debate and difficulty. It’s never easy.  It’s never clear when the “right” time is, if ever.  It’s always risky. Underneath it all you know that you’re ripping out the entrepreneurial heart of an organization.  If you’re going to do something so severe; it damn well better be worth it.  What happens that forces these decisions?

Lust is the first of the seven deadly sins and in an entrepreneurial sense I’m referring to entrepreneurs jumping in and trying to make a quick score; essentially doing it for the money. In contrast, the most dedicated and successful entrepreneurs that I know don’t do it for the money. They do it for the customer, for the product, for the employees, and especially to transform the world.  They do it because they can’t not do it.  The money ultimately is secondary. Lustful entrepreneurs typically jump into an opportunity late and long after others have shown the way. They burn out quickly and are rarely successful.  Once things get tough and their energy flags–which it always does–it’s time for new leadership.

Gluttony is the next deadly sin and that means either raising too much money when you don’t need it—over capitalizing the business–or spending the money you have too quickly. When a company closes a round it’s often a very exciting experience. There is natural euphoria and a realization that a major milestone has been achieved. However, raising the money merely earns you a learner’s permit. Often entrepreneurs are so excited that they immediately spend on all of the pent-up things they’ve denied themselves: vehicles for the senior leadership, new computers, high-rent offices.  All of the things you say you’d do if you only had a little extra working capital.  In effect, the very discipline that convinced investors to support the company is abandoned and the culture suffers.  If a management team has been gluttonous in the way they’ve operated, it’s very likely they’ve run out of money ahead of achieving their major milestones.   This means they’ll be very unlikely to raise another round based on performance.  A leadership change will be inevitable.

Greed refers to the way a company approaches their market. When entrepreneurs get started they typically focus on one market niche and try to succeed by exclusively serving that segment. However, entrepreneurs get itchy and will start to glance sideways instead of forward, trying to own more of a market then they can reasonably serve. They over-extend themselves by attacking adjacencies rather than focusing on the core. This happens frequently when competitors jump into related segments and gain traction. That own-the-whole-market greed leads to a lack of focus. It leads to poor resource management.  It leads to confusion in hiring. It eventually leads to new leadership.

Sloth is the next sin and refers to a tendency to not build on momentum once you’ve gained initial success. Getting that first big customer is often one of the most difficult tasks your company faces.  However, once that happens there is a potential to let off the accelerator and celebrate. Celebrating success is totally appropriate if it’s temporary and brief.  Slothful companies don’t push once the quarter’s been made.  They don’t take a product lead and extend it.  Slothful management is evidenced by a growth that lags the overall market rate and the growth rate of competitors.  If you’re growing slower than your market and your products are at parity, start polishing your resume.

The next deadly sin is Wrath, which occurs when a competitor in a marketplace begins to get traction and a company reacts by attacking them either through what they say or worse what they do.  Cutting prices and destroying the market, poaching employees at crazy salaries, offering services that can’t be affordably sustained–essentially gutting your business model to harm another competitor. This is not aggressive competition.  Aggressive competition brings out the best in the marketplace. Aggressive competition brings out the best in teams. Aggressive competition brings out the best products. Aggressive competition serves customers. But wrathful competition does the opposite and once the process starts it’s difficult to stop.  What you do to your competitors they frequently do back, so employee retention drops, margins drop, growth slows.  Time for a change.

Envy is when you covet what your competitor has.  Whether it’s a unique business process, a novel set of product features, or a certain profile of investor. When you envy your competition very bad things start happening:  you stop innovating and you start imitating. Envy transforms your business from one that is in control of it’s own destiny to one that operates at the destiny of others.

Now, to our situation.  The truth is the founder we just determined to replace committed none of these previous six transgressions.  Indeed, he operated with extraordinary discipline and assiduously avoided them all.  So what happened, why’d he get pushed out?

Pride.  Pride is considered the most venal of all of the sins because it is the most basic. And this was the sin that we were dealing with. Ironically, this person was not a prideful individual. In fact he is one of the most humble leaders I’ve ever dealt with in any entrepreneurial setting. However he committed the worst of the so called sins by not owning up to one elemental error: he brought weak senior people into the company, couldn’t admit it, and didn’t deal with them immediately when their weaknesses were exposed. Instead, he put more burdens on himself, trying to work harder, trying to make up for others’ shortfalls. That meant he could not do his main job of setting the vision, driving the products, and leading the team. Instead, covering for others ultimately diminished him.

By the time we recognized the situation and understood that we were going to miss plan by a mile, there was only one person who we could hold accountable:  the head of the company.  The shame of it is that if he had been willing to make changes in his leadership team early and recognize that some of the people we’re not performing at a high level he would not have been removed.

A huge caveat must be acknowledged here:  The board and investors bear an enormous burden of responsibility for not mentoring him through this process. He is a first-time entrepreneur who built a business from $0.00 to 9 digits in a matter of a few years.  We should have known better and given him the resources to succeed.  We should have helped him stiffen his spine in dealing with the unpleasantness of replacing senior team members.  We didn’t and now he’s paid the price.

Despite the change, he’s still a remarkable company builder.  Indeed, it’s important to recognize that he’s done what few entrepreneurs will ever do in their lifetimes.  There’s no doubt in my mind that he will get another chance and he won’t make the same mistake twice.  And I’d be first in line to give him another shot.

Defending the Indefensible: Private Equity and the Politics of Business

Last week a reporter called from the Wall Street Journal asking if I thought democrat attacks on private equity would intensify now that it looks like Romney is the nominee.  My answer, as quoted (sort of out of context) was:

“What we’re more curious about is how hard Romney will fight back against this line of attack,” he said. “The open question in our minds is what kind of ‘scrapper’ Romney will be and whether he will play defense or offense on this issue.”

This being the modern multi-media era, that quote earned me a call from an ambitious but harried young producer on Lou Dobb’s Fox Business Show asking if I’d come on and defend PE against Newt Gingrich, Rick Perry and an in-the-studio critic:  Josh Kosten.  Josh in an indefatigable NY Post reporter who wrote a book called The Buyout of America:  How Private Equity Will Cause the Next Great Credit Crisis.

This is how it played out:

Lou Dobbs Fox Business Tonight, First Segment

They gave us another shot at each other in the next segment:

Lou Dobbs Fox Business Tonight, Second Segment

All-in-all it was great fun.  My only real goal in going on was not to sound like Gordon Gekko, much to the disappointment of the producers.  Somehow, with Romney now heading toward the nomination, I don’t think this will be the last time we cover this topic.

Fortune Growth Summit

Thanks to Verne Harnish for Leading the Fortune Growth Summit.  It was fun to participate as a speaker, get a chance to connect with some amazing companies and listen to a group of very talented business thinkers  The link to the Gazelles TV channel on Youtube is here.  My after-interview is here:

(embed is sketchy, here's the link if it doesn't work:  http://www.youtube.com/user/gazellestv#p/u/2/JEunw6mE9dA)

Mind Melding with David Brooks

It's hard not to be impressed by David Brooks, particularly when he agrees with you.  The New York Times columnist wrote a piece today called The Talent Magnet in which he discusses the type of open, dynamic environment that attracts the best and brightest from around the world:  

In this century, economic competition between countries is less like the competition between armies or sports teams (with hermetically sealed units bashing or racing against each other). It’s more like the competition between elite universities, who vie for prestige in a networked search for knowledge. It’s less: “We will crush you with our efficiency and might.” It’s more: “We have the best talent and the best values, so if you want to make the most of your own capacities, you’ll come join us.” [Emphasis Added]

The new sort of competition is all about charisma. It’s about gathering talent in one spot (in the information economy, geography matters more than ever because people are most creative when they collaborate face to face). This concentration of talent then attracts more talent, which creates more collaboration, which multiplies everybody’s skills, which attracts more talent and so on.

In one sense, I think Mr. Brooks is right.  Talented people are inexorably drawn to other talented people.  But, his comparison to universities hits the second ring of the bull's eye.  The center target is the competition for resources that companies in the entrepreneurial space face every day:  to amass the most dense collection of human talent and maximize their creative output.  If he wants a model for the US government to emulate, he need drive no further than the 25 square miles around Mountain View, California or similar US venture center.

In Built for Change, we studied several companies–ones I call Transformative–who have competed for these extraordinary individuals with aplomb.  For the most part, they did it in two ways.  First, companies like Southwest and Zappo's fostered an irreverent corporate culture that paid no obeisance to industry conventions.  Indeed, in language pre-echoing Mr. Brooks, the book notes that:

"An irreverent work environment "creates a self-reinforcing magnetic effect that attracts and retains talented people"

The second way Transformative Companies became talent magnets was with something I called non-process processes.  Companies like Netflix eschewed rigid corporate rules around vacation days, face time, and policy manuals.  Reviews are very simple: does the person pass the keeper test?  Specifically, if they told their boss they were leaving, how hard would their boss fight to keep them?  Deadlines and responsibilities are clear, how someone gets their work done is up to them.  

That kind of latitude breeds a fierce loyalty, because most people realize that they won't be given such freedom elsewhere.  Again, from the book:

"…Netflix now finds itself a talent magnet.  Recruiting has become almost effortless…Netflix's potential employees know that this is a place that provides maximal leeway to those who are guaranteed producers."

I hope David Brooks is right and President Obama takes the steps for the US to remain a talent magnet.  All our futures are riding on it.

New Gig…Sort of

In the aftermath of Built for Change, I've picked up a new writing gig as a Contributing Editor at Digital Media Thoughts, with a focus on the Digital Home.  I'll be working with Jason Dunn and several other super smart writers and technologists thinking about the next wave of our increasingly digital lives.  Check out a quick post here.

The Key to Success: Doing Nothing

In today's Wall Street Journal, Christine Rosen has a great review of Is the Internet Changing the Way You Think?, edited by John Brockman.  Article link here.  She cleverly titled the article Pay Attention, Please with the equally provocative subtitle:  The New Darwinian imperative may be 'survival of the focused.'

Thomas Metzinger, a philosopher, argues that the Internet isn't changing the way we think; it is exacerbating the deceptively simple challenge of "attention management." "Attention is a finite commodity, and it is absolutely essential to living a good life," he argues. The way we use the Internet today represents "not only an organized attack on the space of consciousness per se but also a mild form of depersonalization. . . . I call it public dreaming."

These are not the laments of technophobes. MIT professor Rodney Brooks, an expert on robotics, worries that the Internet "is stealing our attention. It competes for it with everything else we do." Neuroscientist Brian Knutson imagines a near future in which "the Internet may impose a 'survival of the focused,' in which individuals gifted with some natural ability to stay on target, or who are hopped up enough stimulants, forge ahead while the rest of us flail helpless in a Web-based attentional vortex."

As the parent of 4 young kids, this is something I worry about a lot.  My children have already developed a concerning attachment to all the electronic devices (imitating their parents unfortunately) that bring staccato bursts of entertainment, news and connection with friends.  I worry they won't be able to function without constant stimulation, including not being able to finish homework and tests in school.  The irony is that they're getting very bad at something I hoped they would never excel at:  Do absolutely nothing.  But now I'm not so sure it isn't a good idea.  These themes were explored in a New York Times article from June called Attached to Computers and Paying a Price (link here:  http://www.nytimes.com/2010/06/07/technology/07brain.html).

The key takeaway:

Scientists say juggling e-mail, phone calls and other incoming information can change how people think and behave. They say our ability to focus is being undermined by bursts of information.

These play to a primitive impulse to respond to immediate opportunities and threats. The stimulation provokes excitement — dopamine squirt — that researchers say can be addictive. In its absence, people feel bored.

Unfortunately, thinking about my own behavior in the middle of a boring meeting, I will often reach for a dopamine squirt via my T-Mobile Slide.  Once it starts it's hard to stop.  Same thing during dinner, while on a conference call, pretty much any time.  You can always tell when someone you're talking with on the phone is doing it too.  There are the long pauses and generic answers to questions.  The scientists sited in these articles seem to suggest that previously we weren't tuning out as much, but is that really so?  I can only assume that before we all had these devices we were either better listeners or more accomplished stealth daydreamers, because there's no way everyone was staying focused the whole time or regularly checking out without anyone noticing.

I argued in Built for Change that the best companies are very good at what I call being Proactively Inactive.  In other words:  intentionally shutting off in order to plan, assimilate information and clear the mental clutter.  They do this on an organizational level; it's structured, scheduled and enforced by the group with social pressure ("If I'm shutting off my Blackberry, you should too.").  But if the scientists are to be believed, those who never forget or who are able to (re)learn how to disconnect as individuals will have the greatest success.