Xobni Man Walking Some thoughts from an entrepreneur

This post is a response to Matt Maroon’s post today called Poker People. Matt talks about how straightforward poker players are with each other as compared to Silicon Valley investors.

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…is when he is a refugee in Austria, escaped from Hungary. He badly wants to go to the United States. I can relate; there have been three or four times in my life when I really wanted something, in the way that you dream about it every night and you put infinite care into every part of getting it. Applying for Y Combinator, to start Xobni, was one of those times for me.

For those of you unfamiliar with Andy Grove, he was the third employee at Intel and its President (and later CEO) for over twenty years. He’s a prolific thinker and businessperson in the valley.

Andy is 20 years old. He had just interviewed with American students from the International Rescue Committee (IRC). These students are picking refugees to bring to America based on English skills, education, etc. He was to find out the results the next day…

“They had read off a list of names. According to people who heard the list, I wasn’t on it.

I felt as if someone had socked me in the stomach, then my heart started beating so hard that I could barely breathe. “Where are the IRC people now?” I asked. Someone said they were conducting another series of interviews at a school some distance away. I took off like a madman. I ran all the way through the cold, dark streets. My heavy shoes hurt my feet as I ran, but I didn’t care.

Sweat was pouring down my face by the time I reached the school. There was a familiar long line of people waiting to be interviewed. I didn’t wait. As the next person emerged from the interview room, I brushed past the person whose turn it was supposed to be and pushed in to stand in front of the table.

The IRC representatives were a different group of students than the ones who had interviewed me the day before. They stared up at me blankly. I didn’t give them time to stay anything. I swiped the sweat off my face with my hands and, still panting, started talking in English as fast as I could.

I explained that I had been interviewed yesterday, that I was not selected, but that I really, really wanted to go to the United States. One of the interviewers asked me why. I told him I had relatives in New York City who would take me in, that I was a chemistry student, that I thought I would become a good chemist, and that I belonged in the United States. The words poured out, not eloquently or coherently, but I talked and talked as if I could overwhelm their objections by the sheer volume of my words. I almost didn’t dare to stop talking, but finally I ran out of things to say. I stood there, panting slightly and still sweating profusely.

The students looked at each other and smiled, then one said, “Okay, you can go to the United States.”

I was speechless. I couldn’t believe my good fortune. I wanted to hug every one of the young men sitting on the other side of the long table.”

I’ve been thinking a lot about APIs lately. Xobni works with MS Outlook; we use its APIs to get to mail data. Xobni’s current value comes from organizing this data in novel ways for our users.

There’s still a ton of great things Xobni can do to (a) tap into other sources of data, including but by no means limited to mail data, and (b) make all of this useful data more accessible to other developers.

Xobni isn’t the only group of developers thinking about this problem. It’s clear to everyone that rich personal and inter-personal information is locked away in data silos.

Social Graph

People are trying to free social graph data, e.g. OpenSocial and the Social Graph Foo camp this coming weekend.

At the end of the day I think it’ll get done. The data is spread through email, social network, IM, and phone platforms, but that won’t stop progress if there is real value to be unlocked. That second piece is what I’m worried about; we are at a lack for compelling use cases of the social graph data. Here are the ones I know of: dopplr, evite invitations, setting permissions based on friendship, and search. What am I missing?

Other Personal Data

People are important but there’s more to life. Facebook, for example, has all kinds of data entities, and all of them are interconnected. It’s a powerful approach. Here’s my illustration.

(Edited: fixed a few accounting mistakes towards the bottom.)

Suppose you wanted to make $1 million per month by selling software. You can either go for a few lucrative customers or lots of low paying ones. A half minute in Excel and you have a table.

Ten minutes in MS Paint and you’ve got a nice graph.

The sweet spot for high margin software offerings seems to be in the sub-$10 per month range. Rhapsody charges $13 per month. Yahoo Mail is $1.60 per month. Mozy is $5 per month. [1]

Enterprise customers pay in the same range for commoditized products. MS Exchange costs about $10 per user per month. FogBugz costs $20 per user per month. I’m sure enterprise antivirus is a brutal market for providers, but I don’t have numbers because they don’t have public pricing.

Enterprise customers are willing to shell out the cash in non-commoditized product categories, though. Salesforce.com charges about $100 per seat per month, but they’re going to have to drop their prices soon because of pressure from Microsoft and others. Bit9 is a new kind of enterprise security, so they’re set for a couple of years.

Anyway, so this is the range we’re interested in:

How do we get 100k paying users? Just for fun let’s assume that you have a freemium model. Most users aren’t going to pay, but some will because they get the bike horn that makes the moooo sound.

The rule of thumb is that about 1% of free users will convert to paying customers. The number varies greatly by vertical, product, etc., but let’s just go with 1%. Some quick math and you have another table.

So if you charge $10 per user per month, and 1% go premium, you need 10 million users to hit $1M in revenue per month. For reference, Outlook has 500M users, Skype has 200M users, and Thunderbird has 8M users.

Skype had about 50M users when they were bought. At that time there were about 4M people simultaneously online, so only a fraction of those 50M were active. Why did they get bought for billions? My guess is that a large portion of active users were paying customers. They were obviously still in growth stage. They also enjoy high margins and had recurring revenue for each user.

So what would $1 million of revenue per month do for you, anyway? $12 million in annual revenue, to be sure. Beyond that you’re back in the land of heuristics. Google has a P/E (price to earnings) ratio of 50. If you got the same ratio with margins of 50% then your company would be worth a nice $300M.

Margins vary hugely by business. Grocery stores get about 2% margins in a good year. Software, luckily, traditionally has high margins because the cost of supporting an additional user is so low. 50% sounds extreme, but consider Skype. They don’t have infrastructure costs, and they probably have no more than 50 or 100 people. That’s the kind of company Xobni can be. This 50% margin on $12M annual revenues can support a burn rate can support a head count around 30 or 40 people. That’s not a bad place to be when you hit the $1M per month milestone.

Other public tech companies have similar but not higher ratios. Redhat is at 65, Yahoo is 50, Sun is 40, Oracle is 30. Microsoft is 20, but damn do they have lots of revenue! Salesforce.com is 1053, but until recently was infinite. They’re still selling the dream.
These numbers can end up all over the board. Zimbra sold for $350M on revenues of about $15M, and probably way lower profits. The list goes on. Growth and strategic value to acquirers seems to have the biggest impact. [2]

With some more elementary school math, we can use these numbers to derive a value per user. An average user on the $10 per month row gets us ten cents per month, or $1.20 per year. That’s sixty cents of profit. With a 50 P/E ratio, that’s $30 per user, not far from Fred’s numbers.

P.S. Xobni is hiring. We are currently looking for great software hackers and a senior QA lead.

Notes

[1] The sad part about these prices is that both Rhapsody and Mozy are low margin businesses. Rhapsody is net losing money per user. Yahoo Mail is a high margin business, but it doesn’t matter because the price is so low.

[2] If you want more examples, look here for a list of MS acquisitions, and have fun googling.

I forgot an important thought in my previous post, Raising Money.

Sam Altman: “Every morning wake up and say to yourself: ‘They need me more than I need them.’ Entrepreneurs are the limiting reagent in the startup equation, not investors.”

Oh so true.

I previously wrote to upcoming Y Combinator companies about:

1 - Having courage to face reality and change direction as appropriate
2 - Raising their next round.

Dear YC Graduate,

You’re presenting to a room full of investors this week. What should you know?

First, your demo will probably break, but that’s okay. Our demo broke. I fixed the code between our demo and the mingling. I remember telling investors “Look it works now!” but nobody cared. : )

Follow the introductions. Your lead investor will likely be a friend of an angel who you met through the advisor you met at your girlfriend’s father’s 55th birthday party.

Joe Kraus has written about this. He says Take a cookie.

Here’s the tree of how we met our investors, of who introduced us to who. Click on it to get the full version.

Y Combinator has the largest branching factor in the tree; they introduced us to nine angels and VCs. 23 out of the 28 investors we spoke with are descendants of Y Combinator in the tree.

I’ve written about the value of Y Combinator before. You’ll basically be borrowing their network. They kick ass. [1]

We spoke with 16 angels and 12 VCs. Angels made 24 introductions; VCs only made four. The average angel introduced us to 1.5 other investors, but the average VC only introduced us to 0.33 other investors. That’s a 5x difference!

So angels can be helpful even if you’re raising a mostly VC round.

It’s an unwritten rule in the valley that if node x invests then every ancestor of x must be given the opportunity to invest. They can’t be cut out of the deal. You can probably figure out why.

Okay, tree stuff aside, you want to have more than one major investor. If one firm is out of line then the other firm will be there to say This is unreasonable. You’ll get more varied inputs. Having more than one major investor means you’ll take a little more dilution, but I think it’s worthwhile.

Our series A didn’t happen quickly. We excited the people we met with, but we were timid about getting started having recently closed a $100k angel round. One firm had interest, so we thought “We better talk to someone else to make sure we’re getting a good deal.” That incremental approach went on for a few months. We were always in late stages with one investor but just beginning the dialogue with another. Deciding to raise money should be an atomic decision; don’t try to just dip your toe in.

You want a small option pool. The investors will tell you that the company needs a large option pool. Balony. The debate is really about who pays for the option pool. VentureHacks has a relevant article.

Traunching is bad for the company. If your investors exercise the traunche(s) then it means that the company is now worth more than they’re paying you, so you’re leaving value on the table. You might want to raise a smaller round and go to the market again when your valuation is higher. [2]

There’s also the 10x rule: you shouldn’t raise 10x more than your last round. I think it’s a pretty good heuristic. [3] (Credit: Josh Kopelman.)

But some people will tell you to take money whenever you can get it. There’s also some truth in that.

At the end of the day I’ve done exactly one financing and have very little experience. There are entire blogs devoted to these topics. I encourage you to read and learn all you can. Ask for help when needed. You’ve got a great network surrounding you.

Good luck, and best wishes,

Adam

P.S. I previously wrote to you about ‘Courage to Change Direction’ here.

Notes

[1] That said, don’t expect them to do the work for you. Just as the summer stage, you get back what you put into it.

[2] Yes, that does mean that you’ll spend more time raising money. And market conditions could change by the time you go to the market again. It’s a trade off.

[3] YC’s initial investment might not apply well as an input to this function.

(The latest group of Y Combinator companies graduate in two weeks. There are some thoughts I’d like to share with them. This is the first of a few letters.)

Dear YC Graduate,

First, I hope you’re excited. I remember the rush of the super early days. Wow, what a rush!

It’s important for you to focus on your demo for the next 10 days before demo day. Focus focus focus, and you’ll do great.

After demo day, though, I think you should consider where you’re taking the company in terms of its market/product/positioning.

You applied to YC with a promising technology and a vision for the future. After working on the company for three months, now would be a good time to do some introspection.

We worked on a product called Xobni Analytics over the YC summer. It was a great product, but not the right product for our market. We scrapped [1] that product and are now working on something much better.

The YC company that became Scribd was working on something totally different over the summer. They realized it wasn’t going to pan out and had the guts to change direction completely.

Do you need a direction change, or are you already on the right vector?

Is your market large and addressable? Does your product solve a real pain? Does it create lots of tangible value? [2]

It’s worth plowing through on your product over the summer without too much thought to Is this a $300M dollar company? But the time has come to ask yourself such questions.

This letter boils down to: Have the courage to say We need to change something. We were wrong about this or that. Be agile; don’t be stubborn.

Notes

[1] I spoke more about this in the ‘Idea Due Diligence’ paragraph of this post.

[2] All of these questions equal, ironically: Is it something people want?

My startup self was born on March 14, 2006. It started asexually, created by its only parent, Y Combinator. I was such an infant. I didn’t know how to do anything other than write code. I could write code really well, but that was it.

During my early years I ran into walls and tripped on toys. We spent five months making a product that nobody really wanted. We missed a key hiring opportunity. I was the only one doing software development.

My teens were filled with growing pains and an identity crisis. Talking to investors constantly, doing a financing, setting up an office, and starting to act like a “real” company. *Wince*

My startup persona is a little older now. I’m learning more than ever, and making more mistakes than ever before. But I am taking more measured risks and making fewer rash decisions. I have some familiarity with the startup world, and have an easier time facing reality. I feel like I’m in my early twenties startup wise. There’s still a long way to go, and it will probably never stop.

People like Paul Graham, Josh Kopelman, and Rob Hayes have been around a while and pretty much know how to kick ass at everything. They’re senior citizens.

Vinod Khosla is 100 years old. You know he knows how to do everything, from chasing ladies (raising money) to retired travel in foreign countries (sitting on the boards of Fortune 500 companies).

I might be completely off the mark when I say I’m in my startup early twenties. Making a statement like that is a huge risk. There’s a reasonable chance that I’m way off the mark, and that five years from now I’ll be laughing at myself. But, hell, guessing is fun.

I’ve been thinking about why programmers/engineers are bad at selling things – products, ideas, themselves.

First, engineers suck at spin. They deal in facts, not emotions. The suspension bridge is going to stay up or collapse. The software works or it doesn’t, and no amount of framing, rhetoric, or rapport will change the facts. An engineer who spins things to themselves or others would be a bad engineer; facts are king.

It gets worse. Not only do engineers focus on facts, they focus on the negative.

Programmers survive by paying attention to the ugliness in their code. If you wake me up in the middle of the night and ask what I’m dreaming about, I’ll probably tell you what the two ugliest parts of our code are, and how I’m going to fix each of them.

So when someone asks me about the code, my instinct is to describe the bugs. They’re just the first order of business! We have a natural tendency to look for and focus on the things that are not perfect.

Redemption

Luckily entrepreneurs know that they need to be able to wear many hats. If you’re already an engineer, you just need to learn how to sell the company, what you’re doing, and the product to people when you’re hiring, raising money, or talking to customers. You need new skills to do this selling.

It’s quite possible to pull it off.

I went to a talk by Bob Metcalfe at MIT in aug-05 where he talked about selling. He recalled his personal journey of learning how to sell. Remember, Bob came into the entrepreneurship world from MIT and Xerox PARC.

Bob said he went through four stages of learning how to sell:

1. Build a better mouse trap and the world will beat a path to your door
2. Once he realized that doesn’t happen, he’d argue with the customer. “You really need this product.” He would win the argument, but that left the customer with a bad taste in their mouth. He told the customer they were wrong.
3. So that didn’t work. He switched to Suffering fools gladly. Tell them what they want to hear. Over promise and under deliver.
4. Finally, nirvana. Listen to the customers, understand their problems, and make sure you can create value for them. Under promise and over deliver.

I’d say I’m at about stage 2.5. When I’m talking to a recruit, my basic pitch is “Your life would be better if you joined us. We kick ass and you’d find much more fun/responsibility/learning here.”

I think this can improve. I’m working on it.

The first screen on any web analytics package is visitors over time. That’s a horrible graph! Traffic over time is really produced by two forces, new visitors and stickiness. These two forces are what really matter.

Stickiness

The left and right graphs below are the familiar visitors over time. The middle graph is stickiness; it says how long the average user continues to visit. For example, the blue line expresses that five days after their first visit, only 10% of users are still coming back. The magenta line is better; five days after their first visit, 70% of users are still visiting.

Three Web Sites

Imagine three web sites – blue, magenta, and black.

Blue is a photo social networking site that requires visitors to sign up before seeing anything. The average new visitor sticks around for 0.13 days, so their Total Visitors closely resembles New Visitors. A couple days into launch they meet with investors and yell “Look! We’re getting loads of traffic!” The traffic is all from Digg, TechCrunch, and Reddit, though; pretty soon they will be old news and their traffic will die, as seen on the Total Visitors graph.

The best stickiness you can get is a constant 1.0, right? Then you would retain all of your traffic and total visitors would be the integral of all new visitors over time. [1]

No, you can do better! Black is facebook. Not only does the average new visitor stick around, but she brings friends and your traffic explodes!

The median web site is actually worse than all three shown here. The median TechCrunch’ed web site will have 5% of new visitors show up the next day. It’s a sad state of affairs.

The Secret

The secret is that New Visitors aren’t that hard to come by. If you’re a startup building a web site, you can get coverage on blogs. If you have the right luster you can get on Scoble, The Today Show, and ABC Nightline. If you’re in a boring market then you can use adwords. If you’re competing with Girl Scout cookies then you can hang a sign outside the Safeway.

It’s easy to get excited by huge traffic spikes when you first launch. You haven’t accomplished anything, though; tomorrow the spotlight will be on another startup. You need both new visitors and stickiness to build a successful business. Stickiness is harder to get, but nobody measures it!

What This Means

All subscription businesses run on one metric – Average Revenue Per User (ARPU). [2] When a decision is to be made, the first question to ask is How will this affect our ARPU?

If you’re building a web site, stickiness should be your key statistic. You should write code to measure it before launching. After you have launched, put it on an LED display outside your elevators.

Announce it at all of your meetings. When making a decision, ask How will this affect our stickiness? And actually measure and follow up! You make what you measure.

Stickiness Built In

Some products have stickiness built in. Social networks encourage you to bring in your friends. Desktop applications have a persistent presence after being installed, so the user doesn’t have to remember a web site name. PayPal has some of your money in your PayPal account, so of course you’ll come back. Interesting writers like Joel on Software or Paul Graham promise to give you new thoughts occasionally, so you’re compelled to always come back. And so on.

So, how can you make yourself stickier?

Notes

[1] The math is simple; total visitors is just the convolution of new visitors and stickiness. For those who had the delight (or misfortune) of a Signals and Systems class in college, this is just a system where new visitors is the input and stickiness is the impulse response.

[2] Thanks to Joe Kraus for the example.