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Something Ventured:
May 31st

Insight For BC Technology Entrepreneurs

By Brent Holliday

A Look at Some New Models

"Dream baby dream,
of all that's come and going,
and you will find out in the end,
that there really is no difference "
-INXS, New Sensation

The term "business model" is abused just about as much as "e-commerce". It means different things to different people. VCs, entrepreneurs and analysts fling this term about as casually as any buzzword. Is it a revenue model? Is it a marketing strategy? My definition of a business model is quite simple. It's the business that you are doing or propose to do, written on a napkin. You know, explain it to me like I'm a six-year-old. For example, one business model on the Internet is to spend lots of money attracting people to a web site and then have advertisers pay you more money for each visitor than you spent getting them there. Simple, eh?

I want to dissect a few existing business models and describe some emerging new ones. It's a bit of a potpourri, but hopefully you can gain some insight related to your company's business model or take a new one and start a new venture.

It used to be that the business model had to make economic sense from the get-go. In other words, it had to show profitability as a very plausible outcome. In the exuberance of the "new economy" created, in large part, by the Internet, the profitability tenet has been tossed out. Case in point, the "sell at zero margin and make it up on advertising" business model being employed by Buy.com and OnSale.com's At Cost. Revenue is not a problem in this business model. Customers love the fact that a digital camera costs 50-100% less on these web sites. As a result, Buy.com was the fastest start-up in history to reach $100 million in sales, eclipsing Compaq's previous record by 4 months. Is this sustainable? Are you really going to drive enough people to the web site at $0.10 an impression from the advertisers, to counter the money lost on sourcing and shipping the goods? To me, the business model is no different than the advertising business model discussed above, only that instead of content, this web site has merchandise.

Amazon.com has a different business model. What started as a simple retail business model (make a mark-up margin over the supplier for providing selection and customer service) without a bricks and mortar store has emerged into something different. Because Amazon.com has the brand, created largely from first mover advantage, they are spreading into all areas of consumer goods and services. Now, they are a market in and of themselves. The new business model will include the retail markup of goods they sell, but increasingly will include the extraction of fees from the seller, whom they are connecting with the buyer. Get it? They will use the Amazon.com location as a portal where Drugstore.com will get customers and Drugstore.com will give them a finder's fee. This is the new portal model that Yahoo and Excite are starting to use. Advertising ain't enough. This is the new, and profitable, middleman: the on-line marketplace.

Paul Allen just announced a new e-tailing company with a unique business model that I like. Unlike Buy.com, Mercata will actually sell merchandise with a margin while still offering a deep discount. The trick is to get group buying power. Why is Costco so cheap? They buy in bulk. Why is Source for Sports able to compete with the big Sports retailers? They buy in a group and get the discounts. On Mercata's web site, if you want to buy a digital camera, you wait to see if 50 others will buy the same model over the next week and then you pay less. The new business model works because information systems and the Internet make instant communication along the entire supply chain possible.

One of the business models that no one predicted that the Internet would enable was the auction. The auction has permeated all kinds of areas on the Internet. From consumer goods to garage sales to initial public offerings in the financial markets, the auction is a new business model. Again, the instant communication power of the Internet allows this to happen. How does eBay make money? Primarily through charging the seller a fee, just like the real world auctioneers. Advertising is a secondary source. The most interesting spin on the auction is Priceline.com. Their business model is to accept bids for your business through a reverse auction. If you want to fly to San Francisco, travel agents and airlines will bid for your seat through Priceline's web site. The best price wins. I bet this model would work for dating, too.

It's not just the Internet that is changing business models. Big changes are afoot in the biotech world as the old business model of drug discovery is changing. It used to be that a biotech company developing a new drug or category of drugs, would be financed by venture capitalists as the drugs went through approval processes. Just to get to Phase II approval used to be 6-8 years and $10 - $15 million per drug. Then the big pharmaceutical companies would come in and buy out the VCs position or invest heavily in a partnership with the company making an IPO possible. Examples of this process abound in Canada. QLT and AnorMED ar two recent examples of this model. But now, consolidation in the pharmaceutical industry and increased expenses of trials have made drug discovery a $50 million process. Now it takes more money and more time to get a drug to market. And the pharmaceutical companies are funding internal drug development more than external. What is a biotech company to do? Try a new model. Something that generates money sooner and does not put the entire business in the 10-15 year to revenue cycle. Synapse is a local company developing diagnostic tests for Alzheimers. Diagnostics is a much shorter business model. Terragen is developing libraries of compounds that big pharmaceutical companies will use to develop new drugs faster. Another shorter business model. These are the new biotech companies, competing for financing dollars in a world where Interent companies can go public in 6 months...

One of the older business models that need a radical change is that of the recorded music industry. The existing model is that a performer and a songwriter receive royalties for their work when a person buys their album or when they are heard on the radio (Interesting sideline: they receive nothing for videos on MTV or Muchmusic because MTV caught the big labels with their pants down 15 years ago. Essentially, videos are for advertising only. The labels are making damn sure they don't get a similar treatment on the Internet). The other major source of revenue for a band or individual singer is the concert. The current handwringing and jockeying by the major record labels is to try and protect the copyright of the work so that they and the artists receive payment. Piracy is a problem. MP3 sites are everywhere. College kids have a CD-R to burn discs to listen to in their cars, dorms or Discman. What is the market saying? Are they saying that a) they pay too much for recorded music or b) that they don't want bundled music in the form of albums. They want to select individual tracks and c) that they want the convenience of the downloadable or streamed format. Answer: all of the above.

The market is telling the old recording industry that the present format doesn't work. An artist receives only a buck or two from the $17 that you pay in the store. Can't the efficiencies of direct digital distribution lower that cost? Of course. Did you know that the Grateful Dead make zero bucks on all of their recorded music? They gave away their rights and put their music in the public domain. How do they make money? Concerts and merchandise. Is there a new business model here? Give away the music in order to get people to come and see you play. It worked for the Dead. The labels can still make a buck or two promoting the bands and selling the merchandise.

The thing about business models is that they are in constant need of upgrading. Look at your existing model and consider what new models might work or what enhancements might add value to the existing model. The business development people in each company live and breathe this changing world every day. If they are good, they can make changes on the fly, creating individual business models that work for each new customer or partner in your venture. If they are bad, they will muddle up the existing business models and confuse everyone as to what business your company is in. Hire business development people that are very creative and aggressive and make sure that the communication lines are open to the senior management.

Some great new companies have emerged because they had the foresight to create a new, viable business model. My hope is that a few of you come up with a great one҆ and call me first.

Random Thoughts

- Is this it? Are Net stocks coming back to earth? Robertson Stephens Web Guru, Keith Benjamin said today that the NETDEX was down 8.9% this week and down 26.5% from its 52 week high. For comparison the tech-laden NASDAQ is down 6.9% from its 52 week high. He suggests, of course, that it's time to buy a basket of lower priced stocks starting with the "blue chip" ones, Amazon.com, AOL, CNET, CMGI, eBay, Lycos, TicketMaster Online-CitySearch, and Yahoo! You be the judge: sign up for his weekly report at http://www.internetstocks.com

- Royal Bank Growth Capital has announced an e-commerce incubator and fund in Toronto with MDC Communications. They have $40 million and will only invest in very early stage companies with e-commerce strategies. This comes on the heels of a report from Andersen Consulting that says that only 26.5 % of Canadian CEOs have already implemented, or plan to implement e-commerce strategies in the next year. While the tendency in Canada is to throw our hands in the air and wail about the lack of vision and risk-taking in our corporations, I see this as an opportunity. If, in fact, the number of implementations of e-commerce products is that low AND e-commerce is as inevitable as an NDP scandal, then there is still time to create a winning product to fulfill the impending demand. The numbers of corporations with full scale e-commerce implementations in the US is not much higher. Let's go people! There is a market to be tapped and investors are signaling that they are interested.

- Here is this month's Horatio Alger story: Two years ago, I had a meeting with two individuals while I was still at Multiactive. They were hoping that we would want to participate in their venture, an on-line grocery business. We had just done a small project enabling on-line meal ordering via Takeout Taxi and they thought there might be a fit. Also, the one individual had just left the Maximizer Technologies part of Multiactive where he had been the warehouse manager. At that point they had basically nothing and we said good luck and that we weren't interested. Besides, many grocery initiatives were just starting and I was not sure that there was anything terribly unique about their offering. So, the guy that ran the three person Maximizer warehouse is now the VP, Business Development for HomeGrocer.com, recently funded by Amazon.com and originally funded by Kleiner, Perkins in the Silicon Valley. HomeGrocer.com has about 2000 users and is no where near the revenue of some of the established players, Peapod, Netgrocer and Streamline. But, you have to just look at their backers and guess that this will be a winner. I guess that working at the warehouse helped our Horatio learn a thing or two about deliveries.

Response From Last Week's Column:

Brent, like so many others, I really enjoy the columns written by you and by Mike Volker!

In the Feedback section today, in response to a question about 'what should I be learning?' you made a comment to the effect that it is helpful to work for a while with a big company 'so you will know what it feels like to get there'. I couldn't agree more! There's lots of good stuff to learn while working for a big company. Sure, after a while it can get boring, but that's the time to move out with the experience you've gained and try to make it on your own.

In my work with growing high-tech companies in this area, the biggest single thing I have found missing is the ability to carry a vision of operating in a BIG company. It's a whole lot different to be the manager of a $100 million or $1 billion company than it is to be the manager of a $5 million company, and the change is scary if you haven't been there, or at least if you can't properly imagine what it is like. I think the missing experience is what prevents so many of our companies from moving into the big league -- too many of our local entrepreneurs have no experience in a big company. The early managers (often the founders) won't hire the people with that experience, or if they hire them won't follow the lead of the experienced people they hire.

Noreen Heselton, the new Director General for SR&ED (Rev Can) remarked in a recent speech, 'Opportunities are not lost -- someone else takes them.' To that I add, 'Opportunity and Risk often go hand in hand -- avoiding Risk usually means missing Opportunity. Success comes not from avoiding risk, but from recognizing the risk and managing it to gain the opportunity.'

Keep up the good work!

Bill Tracey

- Since we're into quotes, here's another from Thomas Edison: "Opportunity is missed by most people becasue it is dressed in overalls and looks like work." Thanks for the supporting comments.

Dear Sir,

I very much enjoyed the read however, I will have to disagree with you on a major point. Young start-up companies do not get a choice of how much they give up in ownership, how they raise money etc.

My name is Brad Smithson. I am the President & co-founder of Pacific Insight Electronics Corp. (PIH-V) in Nelson B.C. We are a VSE public company, founded in 1987. We now employ 175 people building parts for the auto industry. See www.pacificinsight.com.

We started in the basement & grew our sales over the first year with cash in our pockets. Finally, we won the big contract with General Motors. It was a $780,000 contract that we needed $350,000 cash to build. The order was due in 60 days. Even with a GM PO in hand, no bank would touch us. They didn't think that we could pull it off. We finally learned that was possible to go public & get the cash we needed. We jumped through all the hoops and after a year or so we were public. I'm not sure how involved you have been in taking companies public but we found that the first time, you really only learn what not to do. You have not even mentioned that going public basically ties up the business leaders working on stock activities rather than the business. This is a very important point. I've lived it.

I really think that your little story is great because it educates young would-be businessmen on a subject. However, in the real world it seems like you end up with much less choice & you end up accepting one of the very few offers of financing a young guy can attract.

Again, great page.

Brad Smithson

- I have mentioned this point about public companies. Last year, Jerome Gessaroli from (then) Brink, Hudson was a guest in my column and we debated the pros and cons of VC vs. public financing. Further to that column, regardless of what kind of financing you get, it's the people that matter. If you get, along with the financing, access to a superior, experienced, connected set of board members and a pipeline to other contacts that can find you world-class people, then you are in a much better position. in my experience, you don't get that when you go public on the VSE. You better have those people already in place. But, alas, if you are stuck seeking financing, you have to take the money where you can get it. Hopefully there will be more sources of capital in the near future...

What Do You Think? Talk Back To Brent Holliday

Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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