For What Shall It Profit…

For what does it profit a man to gain the whole world, and forfeit his soul?
—Mark 8:36, New American Standard Bible translation

An article in the Verge titled "Inside Pocket: how a startup beat its rivals to build the 'DVR for everything'" prompted me to think about the notion of scale, revenue, and sustainability over my nearly 20 years of work on the commercial Internet.

Way Back in the Long Ago, Children

In 1994, I co-founded a Web development company called Point of Presence Company (POPCO). We funded it ourselves from credit cards and payments from three early clients (Peachpit Press, Faucet Outlet, and Atlas Model Railroad). I brought the first client in; my partner, Todd Haedrich, brought the others (a client of his father's and his uncle's hobbyist company, respectively).

We never really gave a thought to outside funding. I was 26; Todd was 21 or 22. We didn't know from venture capital and nobody knew what the Web was, even if they'd heard of the Internet. Todd's father, who ran a printing company, was pretty savvy and suggested bringing in some outside money. But we decided that we'd rather own everything and grow moderately fast. I didn't want to lose other people's money, and I was content that we had become profitable within a year, paid back our loans, and could afford to hire in help. I hoped to build equity and increase my salary over time.

Todd decided to move east to be closer to home and work for one of our clients, and I bought him out. (We sadly lacked a partnership agreement in our S Corporation, and ruined our friendship sorting out hard feelings over his departure and the value each had put into the business. Always have a "pre-nup" in your business because then you've talked through the stuff you might get angry about later, otherwise, at a point at which you're full of optimism and good will.)

I brought the business to a multi-hundred-thousand-dollar-a-year level that paid me and one employee a salary. When it came time to grow it further, I had a coincidental lunch with Jeff Bezos at Amazon, to whom I'd been encouraging (no, seriously) about his business in its early days, and we would get together from time to time. He offered me a job. I interviewed, had mixed feelings, but took it. I was ready for something new. I sold the business to my friend Scotty, who ran it quite successfully for years until joining Allrecipes.com. (Allrecipes was bought by Reader's Digest in 2006 and sold to Meredith last year.)

Scotty and I created a sweetheart deal, because the business required a shepherd and wasn't in a form that could be easily sold to someone who wasn't prepared to give it his or her all. He paid me out fully over time, and we split the proceeds from a couple of early domain names registered for projects that never panned out.

(I am going to toot my own ethical horn. When Scotty and I sold one of the domain names for a sizable amount to a firm that put it directly to use, we split the proceeds. I then paid out half of my half to a former housemate and landlord. He'd let Todd and me use the basement to run our business essentially rent-free for eight months, and was responsible for the domain name being registered in 1994 as he and I discussed a possible venture. We didn't have anything in writing. I gave him half of my half because of his trust and involvement. I'll be honest: I didn't love writing the checks; I did love giving him the money. I have sometimes been on the receiving end of this kind of combination of gift and payback; sometimes, people have been too greedy to remember anyone else helped them.)

Now could I have made POPCO into a multi-million-dollar hosting, design, and development firm? Probably yes for a little while, but not for long. The range of somewhat similar firms launched with huge budgets or VC around the same time, whether MecklerWeb (focused on publications), USWeb, or Organic survived for long. MecklerWeb changed its model entirely; USWeb was in bankruptcy before 2000; and Organic, after an IPO, went private and dramatically reformed. More or less, all the Web development firms of 1994–1996 either disappeared or became part of ad agencies.

In contrast, I had employment for two years, had a long-term payout with some bonuses (from the domain-name sale), and my clients had the benefit of continuity and care. Scotty made a living from it for years until he was ready to transition out into cashing a paycheck as well.

Neither of us valued money enough to build something with high valuation and low sustainability.

Get Big Fast? Get Out Fast. 

I've written elsewhere about my time at Amazon. Being there from October 1996 to May 1997 was pretty amazing. The business was growing like gangbusters, and every day brought new adventures and disasters. There were many points while I was working at the company that the whole business could have collapsed, not through neglect, but just because of the problems of scaling so rapidly and trouble with other firms with which we worked who weren't able to cope with our growth, either. It gave me a distaste for getting big fast, because the risk was so high.

And I saw other firms stumble and fall. Amazon made it through the dotcom collapse not on profit, but on bonds and volume. It had managed to raise enough money at the right point in time that even though it spent very poorly in the late 1990s through 2001, it weathered the storm. Even today, though, its profit margin is paper thin. Matthew Yglesias put it perfectly in January 2013: 

Amazon, as best I can tell, is a charitable organization being run by elements of the investment community for the benefit of consumers. The shareholders put up the equity, and instead of owning a claim on a steady stream of fat profits, they get a claim on a mighty engine of consumer surplus. Amazon sells things to people at prices that seem impossible because it actually is impossible to make money that way. 

This apparently irked Bezos, who replied in a shareholders' report earlier this year:

I don’t think so. To me, trying to dole out improvements in a just-in-time fashion would be too clever by half. It would be risky in a world as fast-moving as the one we all live in. More fundamentally, I think long-term thinking squares the circle. Proactively delighting customers earns trust, which earns more business from those customers, even in new business arenas. Take a long-term view, and the interests of customers and shareholders align.

But after 19 years in business, is it legitimate to say that you're still working on a long-term plan in which you've already become a multi-billion-dollar company without securing decent margins? That seems a bit hard to swallow. If you can't perfect this model after this long at this scale, what hope do you have in the future?

My time at Amazon convinced me of the futility of chasing the hockey stick for users and revenue. You hear this sports metaphor all the time: it's the effect in a line graph in which growth goes from flat or moderate to a sudden massive uptick. It looks like a hockey stick in the chart.

But when you increase users and revenue in such a way that each new person costs you more money instead of keeping you steady or producing a return, the hockey stick effect means you've gone from throwing matches at piles of money to soaking the bundles in kerosene and using a flamethrower. And some company founders ask for more fuel from investors rather than figuring out a way to suppress the fire.

Some companies will succeed this way. They need a certain level of scale, and must have a hockey stick in advance of net earnings to achieve the economy of scale necessary to change an industry, squeeze margins from suppliers, build the right infrastructure, or what have you, and then have returns on investment that are positive, consistent, and make sense at their level of revenue. They go out and raise millions to billions of dollars from capital markets where supposedly rational players — who seriously aren't — believe that the risk is worth the potential high rate of ultimate return in the form of a rise in share price.

Amazon so far looks like a grocery chain. Grocery chains have massive, massive revenue in exchange for extremely slight margins, but the revenue is so huge that the thin margin generates a huge amount of net cash for owners or shareholders.  Amazon doesn't look like Apple, and it likely never will, because it is a middleman in most of its businesses, and middlemen only get a taste, especially where competition exists. (Apple is in that position only for media, which is a small portion of its earnings.)

Amazon's virtual server and data business is likely the engine of high margin and true profits for the firm over time, even as it faces lots of current and lots of future competition. There could be a time where the entire physical fulfillment part of Amazon makes almost no money, but the company is highly profitable because of its online media sales and Internet services business.

Moderation in All Things

Why try to make an Amazon when most such efforts fail? The promise of a "win" is so huge that it motivates people. It is possible to become a multiple millionaire or billionaire by founding a business such as this, and that drives some people in this direction.  I have never been driven by obtaining money, though I certainly have been motivated by a lack of money.

It requires a huge ego and huge smarts to believe you can beat the odds and reach the scale you need to produce a return. The ego part is fine if it isn't out of control and leads one to have a distorted view of reality. Steve Jobs' monstrous self-regard is often cited as a negative and a positive; since he built one of the largest and most profitable companies in history, his ego may actually have been in scale with his efforts. (Jeff Bezos was a pretty modest and nice guy when I knew him. No idea what he is like today, but I am a frequent critic of his firm's business and employment practices.)

But for me, it's more like a great high-school basketball player reaching the NBA. So many kids want it, because it's a ticket to money, fame, and some kind of acceptance they must crave and not have. (There are some NBA players who are just great at it and we don't hear much about such modest ones.) We all know that a tiny tiny percentage of good basketball players will wind up with a contract and a career. Pinning your hopes on the NBA has better odds then the lottery but much more heartbreak. (For football, hockey, and boxers, it's more brutal, since many will incur injuries that will debilitate them later.)

The success rate of companies making it up the hockey stick is certainly higher than athletes who leap from amateur play into a successful pro career. But the aspiration is the same. Building a sustainable business that doesn't require improbable, against-the-odds success seems more boring but produces more rewards. Even if you fail, the failure doesn't take you down with all your early family and friend and later-stage professional investors, lose customer data or disrupt their lives, and leave you picking up the pieces for a hopeful next act. A modestly sized business that builds on success is more fleet at making changes, and even if it fails, is less likely to have a cascade of bad results.

The funny thing is that Amazon is a "success," of course, even if it's not turning much profit or isn't consistently profitable.  It has served hundreds of millions of customers, has developed a lot of interesting current and future business models, and it generally delights its customers, including me (if not its suppliers, who it pinches and sometimes crushes, and its warehouse employees, who work under ridiculous conditions even compared to other warehouses and industries). It is to my benefit, if not society's, that Amazon has dedicated itself to marginal charity.

That's as opposed to say, Instagram, which hockeysticked on users, but not revenue. It was "successful" in that its founders, employees, and investors were cashed out by Facebook. It is not a business success story. And yet it is cited as one. The success rate of Instagram-like companies is even lower than those of Amazon-like firms. I know of two Instagram-like firms that arguably had better products that didn't get the viral uptake and failed to ignite. (One turned into App.net.) There are plenty of others.

There is room for many Instagram-like products, but not if they all try to compete on the same basis of achieving scale rapidly and then being purchased. This wasn't true in, say, 2001 or even 2006. It was simply too expensive to scale one's offerings in terms of servers and bandwidth, or even to work with payment processors who would let you scale collecting revenue. That is simply not the case today. The vast drop in price and difficulty of launching large-scale services means you can self-fund a very large range of Internet services. (Yes, services that require physical goods need much more capital, even though they still benefit from server/bandwidth commoditization.)

The odds of an Instagram "succeeding" are probably 100-to-1 against, if not much higher. And the approach might put money in the pockets of founders and investors, and sometimes early employees, but it is rarely a path to a sustainable business that continues to build on the reasons why users signed up in the first place in droves. (Cf., every Google product.) 

This is why the Verge article got to me. 

Verging on a Ludicrous Definition

First, I have no animosity towards the Verge. I was excited when it launched and still am now. An entirely salaried newsroom team (which I believe is still the case?) coupled with great design, photography, and video covering technology on a timely basis as if they were a newspaper. No other site has been able to pull off the depth and range. This isn't meant as disrespect to many sites I know and love and write for or have written for. The Verge set itself up as a technology newspaper delivered as a Web site.

A lot of money got thrown at the Verge. We don't know if it's "successful," really; that's ostensibly a long-term proposition that its investors are betting on. (Buzzfeed, despite its listicles and methods of sourcing photographs, is another to watch as it turns its huge war chest of investment towards straight news and covering politics.) I don't always think the Verge gets it right and I sometimes object to the tone or even factual accuracy of some of their articles. On the whole, though, I admire the publication and its editors and writers.

Second, I have no animosity toward Pocket. I chat regularly on Twitter with one of its lead developers. I don't tell people to not use it. While I bought The Magazine from Marco, I didn't buy his disagreements with Pocket's people. There is some water under the bridge there, I know, and it's not my river.

(Related, I think Marco's by-and-large refusal to talk to most reporters after being distorted so many times, has led to negative coverage of perfectly ordinary things he does or says. He has publicly called out the Verge for what he thinks is biased or inaccurate reporting; they now seem to exhibit a negative attitude towards him in what should be unbiased editors. For instance, the Verge paraphrases Marco's post on selling a majority interest in Instapaper from his blog entry and his Accidental Tech Podcast as, "He had lost enthusiasm for the product over the past year..." I don't recall him saying those words in any forum, and it seemed to me Marco discussed repeatedly that it felt to him as if he were continuously disappointing people. He wanted to find a firm that would take over the product and run it for the long haul to meet his commitment to those users. That's not the same as losing enthusiasm; he lost enthusiasm for feeling like he was drowning. At some point, I'll write about why Marco is seen as monstrously arrogant and an awful person, when he is neither. I have ideas about this.)

Finally, I am not dismissive of people who want to build a big, amazing company that does things that no one has ever done before or disrupts an existing industry to get there, and requires scale. There will always be firms like that, and one needs massive amounts of money to develop chips, drugs, and national and international scale businesses. This is why venture capital and the broader capital markets exist: to fund ventures based on an assessment of potential returns weighted against risk factors greater than having one's money work less productively.

You know: 

Once I built a railroad, made it run,
Made it race against time.
Once I built a railroad, now it's done;
Brother, can you spare a dime?  

But I did not like the headline of the Verge article, nor this statement: 

The Pocket team thinks of itself as a sister to companies like Evernote and Dropbox, services that allow you to save something in one place and access it later from anywhere. But those companies, founded around the same time, have grown much more quickly. Evernote has more than 60 million registered users; Dropbox has more than 100 million and says it is profitable. Meanwhile, Pocket has more than 9 million users and expects to hit 10 million this summer. After making its app free last year, the company has no revenues.

The company has no revenues. 

Matthew Inman, the cartoonist behind The Oatmeal, makes a smiley face out of over $200,000 in cash he raised in donations. 

Matthew Inman, the cartoonist behind The Oatmeal, makes a smiley face out of over $200,000 in cash he raised in donations. 

Beat It

Evernote and Dropbox have freemium models and charge for service. Instapaper has free offerings, but charges for its app and access to certain features on the Web. Pocket has "no revenues" but it emulates Evernote and Dropbox. I'd argue during the time that Evernote and Dropbox were being used more as a free service, they didn't precisely have competition. Evernote still has a lot of unique elements that other services don't match. Dropbox competes effectively against Apple, Google, and Microsoft — and Box, a more direct challenger with a business focus — by being ecumenical to and supportive of both user and developer needs.

Pocket, on the other hand, has a lot of competition, and did before it was founded and will continue to have it in the future. They can only capture part of the market for read-later services, and trying to hockey-stick on users who pay nothing seems problematic. Tons of people I know use Pocket; many cite the free factor for using it.

Others, like me, use Instapaper, as we like to pay for things that we want to be sure last and that have utility. I, like many, have been frustrated by missing pieces in Instapaper, like a browser plug-in; but its utility and my multi-year archive of past articles stored there, as well as my goodwill for Marco, keep me using it. I've already learned to use it. I've also already paid for the app. While free is appealing before you pay, after you've purchased it's much less so.

This also got to me: 

At some point Pocket will need to start generating revenues — through affiliate links, deals with publishers, or other means. For now, though, [founder] Weiner says Pocket is thriving as an independent company. 

It is thriving as an independent company because it raised $7.5m in investments. That is not "thriving" in the typical definition of how one describes a going concern. That is "having sold an undisclosed portion of the company against the future necessity to make one's business model produce the right return for those investors, however long-term they are in their thinking and patience, or senior management will be kicked out and replaced with people more oriented towards monetization."

I could be wrong: the investors may have a minority stake and the founder retains majority voting control and other safeguards. That hasn't been discussed publicly.

But it does challenge the notion that Pocket has "beat its rivals."  

Pocket bought itself time to grow and mature at a faster pace and without focusing on its revenues and expenses by accepting investment. In this process, it hopes to acquire enough users that a freemium or advertising model may enable it to produce a return that covers its costs. However, accepting investment from typical VCs means that Pocket now has a path set for it: It has a time limit on when it has to sort out its revenue and earnings model. Its end goal now isn't profitability, but a high-enough rate of return to justify the investment. The outcome will be a sale or an IPO. Staying private and independent indefinitely, unless the company structured a very nice deal indeed, is very unlikely in my experience.

I don't see how its current situation with 9m free users is "beating" anyone. If Instapaper has millions of free users and 100,000s of who have paid for the app or for a Web subscription, has it been "beaten"? And if so, is it "beaten" at this point in time when it is cash-flow positive and Pocket is not? These questions aren't asked nor answered in the Pocket profile.

The model that Marco followed with Instapaper and with The Magazine involved making revenue exceed expense. Asking people to pay for what they needed and offering a limited amount free to let them know it might be something they want. It's also the driving force behind Maciej Cegłowski, who created Pinboard, an "anti-social" (personal) bookmarking site that requires payment to use. (He, like Marco, is also a terrific writer on top of being a programmer.) Maciej  wrote an essay in 2011 called, "Don't Be a Free User" that explains his point of view well. He abjures:

...stop getting caught off guard when your favorite project sells out! “They were getting so popular, why did they have to shut it down?” Because it's hard to resist a big payday when you are rapidly heading into debt. And because it's culturally acceptable to leave your user base high and dry if you get a good offer, citing self-inflicted financial hardship. 

(Of course, this could be seen as applying to Instapaper. I'd argue otherwise. Marco wasn't structuring Instapaper to be sold, nor making short-term decisions. After five years of operation, he sold it to a company that he believes is best aligned with the product's long-term evolution and his customers' interests. Marco also got lucky with Tumblr, where he was the first employee; he didn't make the deals nor structure his life around reaping a reward from it.)

Getting big slow has its advantages. You retain control. You disappoint fewer people. You can pay yourself. If you're lucky, you have money you can use to buy a house or pay off a mortgage, get a nice car or start a charity. When and if it gets too big for your scale of comfort — for Marco, that was "beyond his ability to manage himself" — and you're profitable with happy users, you can find someone to buy it, often with the same set of beliefs.

We need to move beyond the NBA as a model of starting businesses. We need to move beyond users and revenue as a measure of success. And a business that accepts investment without revenue nor a clear plan to profit hasn't beaten anything — not even the odds.