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Long Read

The Fashion Supply Chain Is Broken

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By Brian Laung Aoaeh and Lisa Morales-Hellebo

Originally published at www.refashiond.com on October 14, 2018.

Authors’ Note: This is the first in a series of six articles about problems and opportunities in global supply chains, with a focus on the fashion industry. This article frames the problem. The next article will delve into a historical analyses of technological disruption, from the perspective of risks and uncertainties for the fashion industry.

Executive Summary: Recent trends present incumbent companies in the global fashion industry with challenges and opportunities related to innovation in supply chain. In this article, we discuss how a historical top-down approach to business is giving way to an emerging bottom-up approach that is driven by consumer preferences. This is placing stresses on fashion supply chains which the industry can only address by adopting a collective, collaborative, ecosystem-driven approach to innovation.

The fashion supply chain is broken and must be refashioned. This is the conclusion we have come to after studying the issue, starting in 2014.

About The Authors

After 19 years in tech, Lisa Morales-Hellebo founded and launched the New York Fashion Tech Lab in 2014 with Springboard Enterprises and the Partnership Fund for NYC while serving as Executive Director for the first year. She then spent a year traveling to Puerto Rico to visit apparel factories, maker labs, cut-and-sew shops, ateliers, and universities in order to learn about the existing apparel supply chain and the challenges it faces.

Brian Laung Aoaeh, CFA spent 10 years in investment research and management, with 2 of those 10 years as the first and only member of the corporate development team at KEC Holdings, a single family office, and 8 of those 10 years as the first member of the small team that built KEC Ventures, an early-stage venture capital investment firm based in New York City. KEC Ventures grew to $98M of AUM across two funds, with 51 investments. Brian was a partner at the fund from its inception till his departure in September 2018.

Our interest in supply chain originated independent of one another. We first met in June 2016, and spent hours talking about supply chain at our first encounter.

After having started thinking about value chains[1] in 2014, by August 2017 Brian had decided to become a specialist early stage investor in supply chain technology after having been a generalist early stage venture capitalist up till that point. So we teamed up and started The New York Supply Chain Meetup: to nurture and grow the world’s foremost open, global, multidisciplinary community of people devoted to building the supply chain networks of the future. Driven by our shared enthusiasm for all things supply chain and our belief in what the future of supply chain will resemble, we are now on the verge of launching sister chapters of The Worldwide Supply Chain Federation: a collaborative, and mutually supportive coalition of grassroots communities focused on technology and innovation in the global supply chain industry.

In September 2018 we decided to team up to build REFASHIOND; an early-stage venture fund that will invest in the startups creating innovations to make global supply chain networks more efficient, starting with those reinventing the fashion supply chain.

Our Goal: To Catalyse Industry-wide Dialogue & Action

In engaging in the work that has gone into this article, and those that will follow, we hope to start an industry-wide conversation about tangible steps that participants in the fashion industry can take to arrive at a common framing of the problems confronting the industry, and then to find ways to work together to address those problems that can only be solved effectively through collective action. We encourage you to reach out to us if you’d like to discuss any aspects of this work, or if you’d like to collaborate with us in some way. Given our conversations with the industry executives in our network with whom we have the closest relationships we know supply chain, technology, and innovation are topics that every executive management team in the fashion industry is discussing and thinking about to some extent. It is time to start taking collective action to tackle the big issues. Please reach out to us by email;

  • Lisa Morales-Hellebo — lisa@refashiond.com, and
  • Brian Aoaeh — brian@refashiond.com.

A Bit of Historical Perspective

It is easy for outsiders to assume that the history of the fashion industry is completely divorced from that of technological innovation. That is wrong. In fact, the history of fashion, apparel, and textiles can be linked directly to some of the most important inventions of the industrial revolution.[2] A few key examples are the Fly Shuttle Wheel to allow one weaver to do the work of two; the Spinning Jenny, which increased wool mills productivity, the Cotton Gin, Power Loom, yarn Spinning Mule, the first factory, and even materials and textile innovations, like those used in the Mackintosh Raincoat.

Having acknowledged the role technological innovation has played in the history of the fashion industry, it is fair to ask: Has the industry’s more recent history lived up to the technological promise of the current era? That depends. We argue that the fashion industry’s incumbents’ collective investments in the industry’s supply chain have failed to keep pace with changing consumer expectations, expectations that change ever more quickly as advances in digital media and telecommunications unfold and shape consumers’ expectations of when and how to shop.

This is creating challenges for the industry as a trend towards shorter, less complex supply chains appears to be in the early stages of supplanting the long, global, and highly complex supply chains that accompanied globalization and large companies’ insatiable quest to outsource their manufacturing to foreign markets with the lowest combination of fixed and variable costs.

A Definition, And A Reiteration Of The Problem

Throughout this discussion, we will rely on the following definition of supply chain. A supply chain is:

A network of connected and interdependent organisations mutually and cooperatively working together to control, manage and improve the flow of materials and information from suppliers to end users.[3]

To reiterate the problem;

  • First: The fashion and apparel supply chain is broken and must be refashioned.
  • Second: Innovation is happening so fast and is so complicated that there isn’t a single company in the fashion and apparel industry that can reinvent itself quickly enough to take full advantage of new technologies and innovations. Instead, the industry needs to consider taking an industry-wide ecosystem approach to adopting technology and innovation.
  • Third: Because fashion and apparel is the world’s second largest polluting industry, the future of our planet depends on the industry adopting technologies that will accelerate the move towards more economically and environmentally sustainable supply chains.

According to FashionUnited, the global fashion industry is valued at $3 trillion in annual sales, with the United States accounting for approximately $400 billion of the global total. According to the New York City Economic Development Corporation’s Fashion.NYC.2020 report, New York City’s fashion and apparel retailers generate about $15 billion in sales, annually. It is inevitable that an industry of this scale will face supply chain challenges. Yet, as a whole, the industry has been slow to adopt digital technologies to aid in solving the supply chain issues it encounters.

The Current Paradigm

Predicting & Dictating Trends: Style and fashion has historically been dictated by a top-down system of influential designers and tastemakers who set the standards for beauty, taste, trend, and style. The rise of social media has created an unprecedented shift from top-down to bottom-up style and trend mandates, where the designers and tastemakers are now looking to street style, emerging brands, and influencers for inspiration and ideas about what consumers want. A team of trend-trackers monitors global social phenomena, hoping to observe the behavior of youth tribes and other emergent youth-driven phenomena that may be transformed into global fashion trends. The trend-trackers job is to record such phenomena and supply the information to industry clients, while also advising on brand strategies, developing marketing tactics, organizing events, and even providing designers and stylists who may design an entire collection for a brand. This process can take anywhere from 6 to 18 months. By the time it is complete the trend may already be out of style, and the result may be unsold inventory.

Sourcing & Materials[4]: Apparel sourcing is becoming more challenging due to; rising labor costs in foreign markets, increasing compliance costs due to alleged and documented labor abuses in far flung apparel manufacturing hubs in developing countries, and increasing consumer preference for sustainable methods of production as the effects of climate change come into stark relief.

Design: Designers work very closely with trend-trackers to anticipate consumer tastes, and to design clothes that they expect consumers to buy. However, by the time new designs find their way into retail showrooms, consumer tastes may have evolved away from the trend that inspired the designs.

Manufacturing: Apparel manufacturing is largely labor-intensive, concentrated in low-wage countries that are far away from most major fashion and apparel consumer markets, and subject to abuses such as the use of child-labor and slave labor. The process is inefficient, slow, and prone to quality control issues.

Distribution: Consumer behavior is forcing a convergence towards omni-channel and multi-channel distribution with increasingly decentralized warehousing, technological complexity arising from multi-platform selling channels, last-mile logistics, and automation all playing parts in making todays apparel supply chain more complex to manage than in the past.

Sales & Marketing: Technology has provided numerous distractions and shortened attention spans, making it more difficult for fashion and apparel brands to cut through the noise long enough to generate sales. Technology is also making it much easier for consumers to engage in comparison-shopping before they make a purchase.

With the proliferation and popularity of on-demand business models, consumers’ shopping behavior is shifting away from norms the global fashion and apparel industry is accustomed to and can control, and towards norms that favor consumers’ preferences. This shift is resulting in the hyper-segmentation of consumers who used to be seen as too “niche” to address because expectations built around sales volume didn’t make sense, or the industry deemed certain consumer segments as not meeting the standards for beauty imposed from the top. Plus-sized clothing is only recently being accepted as the untapped opportunity that it has always been in the United States where the average woman is a size 16, according to Racked.com’s article, “Size by the Numbers.”

Factors Driving Industry Profitability

Below, we highlight a few measures of profitability. There are others, but for brevity we have chosen to focus on a handful. To do analyses of this sort it is most useful to analyze trends over time for a company, and then compare that data on a relative basis to data for the industry as a whole or to data for a designated subset of peers.

Gross Profit Margin: Gross profit is measured by deducting cost of goods sold from revenue, and gross profit margin is calculated by taking the ratio of gross profit to revenue. Gross profit and gross profit margin reflect a company’s pricing power, the power exerted by its suppliers as reflected in its cost of goods sold, as well as the impact of competition.

Operating Profit Margin: This is also often referred to as EBIT Margin. It is calculated as the ratio of operating profit to revenue, with operating profit obtained by subtracting operating expenses from gross profit. Operating profit margin is a measure of how variable costs affect a company’s profit margins, and can be used to assess how much control a company has over the costs associated with running its operations. One-time charges should be excluded from the calculation. In the fashion and apparel industry generally, we expect that IT infrastructure investments that are required to operate in a multi-platform and multi-channel environment, increasing freight and supply chain logistics costs, as well as labor inflation in foreign markets will each have a negative impact on operating profit margins. Moreover, as we have previously stated, the trend towards increasing marketing expenditure in order to hold consumers’ attention long enough to generate sales will also have a negative impact on operating profit margins.

Return on Equity (ROE): A firm’s return on equity is calculated as the ratio of net income to average shareholders’ equity. It is a measure of how effective a company is at converting its assets into earnings growth. For example, if ROE is 15%, a dollar invested generates 15 cents of assets for the business. ROE is affected by revenue, selling and general administration expenses, taxation, operating efficiency, and inventory management. Management may use share buybacks to offset declines in ROE.

Inventory Turnover: The inventory turnover ratio is an efficiency ratio that measures a company’s effectiveness at generating sales from the inventory it holds. It is calculated as the ratio of cost of goods sold to average inventory. Inventory turnover ratio is affected by the rate at which sales occurs, which, in-turn is dependent on consumer sentiment. Companies in the industry often overestimate how much to stock in inventory, leading to steep wholesale and retail discounts. In the worst cases, inventory that cannot be sold is destroyed.

Earnings Per Share (EPS) Growth: Earnings per share is calculated as a company’s net income minus its preferred dividend payments, divided by the weighted average number of shares outstanding. Generally, earnings per share is affected most negatively by factors that reduce net income. As the industry generates increasing proportions of sales from the BRIC nations and other emerging markets, foreign exchange risk imposes negative pressures on revenues and net income. It is important to note that companies can easily manipulate earnings per share growth by instituting share-buyback programs.

Inventory Forecasting & Management Issues

The issues at play here are illustrated best in H&M, a Fashion Giant, Has a Problem: $4.3 Billion in Unsold Clothes a story by Elizabeth Paton that appeared in The New York Times on March 27, 2018. The article highlights a drop in quarterly sales accompanied by an increase in unsold inventory. According to the article, H&M’s customers have either moved to doing more of their shopping online or have gone seeking lower-cost offerings elsewhere. This is ironic since H&M has been a fast fashion stalwart for two decades during which it has experienced massive growth. The article describes some of the supply chain challenges H&M is grappling with, and how the company intends to respond: “H&M has insisted it has a plan, saying it would slash prices to reduce the stockpile and slow its expansion in stores. It said it hoped its online business would expand 25 percent this year.”

Lack of Efficient & Agile Supply Chain

What happens when the information or forecasts at one node in a company’s supply chain is incorrect? Incorrect information at any node in a supply chain creates a phenomena wherein the flow of goods is unexpectedly distorted over time due to differences between actual demand by end-consumers and forecasted demand by suppliers.

The phenomenon is known as the bullwhip effect, and it arises because demand signals are incorrectly amplified as information is transmitted along the supply chain. The bullwhip effect arises due to; poor coordination along the various nodes in a supply chain, and rational decisions that are made by supply chain participants using the best information at their disposal. The distortions are made worse because of the uncertainty that accompanies activities at every point in a company’s supply chain. The general consequence of the bullwhip effect is poor customer service.

How might a fashion company counteract the bullwhip effect? First, some companies are reversing the effects of globalization by creating the cyber-physical infrastructure required to enable networks of small-batch, quick-turn, and localized manufacturing hubs in order to make it possible to manufacture goods for consumers in the key markets of Western Europe and North America in small batches, closer to the ultimate end-consumers. Second, some companies are developing and using more advanced software for predictive analytics. Advances in artificial intelligence make this a much more feasible proposition today than at any time in the past. Third, some companies are improving the real-time flow of predictive information and data between key nodes in the supply chain. This allows every participant in the supply chain to anticipate future demand more accurately, and to stock raw-materials inventory more efficiently. We will discuss the technology trends that are making solutions to this problem possible in the fifth article in this series.

Conclusion: A Race To The Bottom?

Prevailing economic, social, and technological trends point towards a challenging future for the global fashion industry. Incumbent players may choose to operate with a business-as-usual attitude. Alternatively, they may opt to address the industry’s supply chain challenges by adopting an ecosystem-based approach to solving the problems that are too big for a single company to solve on its own. This will require adopting a systems-thinking approach to how companies in the industry are run, and how they view their relationships with one another.

The companies that win will adapt to the changing landscape by building on their historical strengths, while simultaneously developing new supply chain capabilities through partnerships with former sworn rivals or relatively new technology startups.

The companies that lose will remain entrenched in the old ways of doing business, following one extreme round of price-cuts by even more extreme discounts. This race to the bottom will be exacerbated by additional measures like reducing the number of brick-and-mortar locations — measures that do nothing to solve the fundamental problem: The fashion and apparel supply chain is broken and must be refashioned.

Next in the series: Where Will Technological Disruption In Fashion Come From?

About REFASHIOND Ventures: REFASHIOND Ventures is an early-stage venture capital investment firm that is being formed in order to invest in early-stage startups creating innovations that make global supply chains more efficient, starting with startups at the intersection of fashion and retail.

About REFASHIOND CO:LAB: REFASHIOND CO:LAB is the systems design, research, and strategy consulting arm of REFASHIOND Ventures. REFASHIOND CO:LAB helps organizations create competitive advantage through supply chain innovation.

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[1] One may think of a value chain as a company’s internal supply chain. The term is used to distinguish internal operations from operations that rely on a network of external parties.

[2] McFadden, Christopher. “27 Industrial Revolution Inventions That Changed the World.” Interesting Engineering, 18 Feb. 2018, interestingengineering.com/27-inventions-of-the-industrial-revolution-that-changed-the-world. Accessed Oct. 12, 2018

[3] Christopher, Martin. Logistics & Supply Chain Management: Creating Value-Adding Networks. 4th ed., Financial Times Prentice Hall, 2011.

[4] Berg, Achim, and Saskia Hedrich. “What’s next in Apparel Sourcing?” McKinsey & Company, May 2014, www.mckinsey.com/industries/retail/our-insights/whats-next-in-apparel-sourcing. Accessed Oct. 8, 2018.

Originally published at www.refashiond.com on October 14, 2018.

Industry Study: Ocean Freight Shipping (#Startups)

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Ocean Freight Cargo Ship
Ocean Freight Cargo Ship | Image Credit: Pixabay

Co-author: John Azubuike (@jnazubuike), KEC Ventures.

Note: This article does not necessarily reflect the opinion of KEC Ventures, or of other members of the KEC Ventures team.

Supplying the world with nearly everything is an enormous and complex job: there are things to discuss. 

– Rose George (2013-08-13). Ninety Percent of Everything: Inside Shipping, the Invisible Industry That Puts Clothes on Your Back, Gas in Your Car, and Food on Your Plate (p. 142). Henry Holt and Co.. Kindle Edition.

Introduction

Although it is largely hidden from the day-to-day experience of most people, maritime shipping is central to the modern system of international trade and the way our world operates.

According to the International Chamber of Shipping, the international maritime shipping industry transports about 90% of all physical goods traded internationally. To give that some further definition, the World Trade Organization estimates that, in 2014, its members collectively exported merchandise worth $18 trillion.

The U.S. Census Bureau estimates that in 2015 seaborne trade in the United States amounted to $1.56 trillion, with imports accounting for about 67 percent of that total.

Despite its size and importance, the ocean freight shipping industry has remained largely untouched by the kind of transformation that software technology has imposed on other markets. That is beginning to change as a number of startups attempt to build products to serve that market. This post represents our attempt to understand the landscape within which such startups operate.

In the rest of this discussion, we will refer to “startups” as distinct from “companies”. To ensure we are on the same page;

  • A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model. 1I settled on this definition after reading the work of Steve Blank and Paul Graham.
  • A company is what a startup becomes once it has successfully navigated the discovery phase of its lifecycle. This is the phase during which relatively fixed organizational structures start being built in order to facilitate the firm’s work on behalf of its customers, employees, shareholders, business partners, and society.

KEC Ventures invests in early stage startups. Therefore our primary purpose in studying the ocean freight shipping market is to gain adequate context for the instances when we might assess pre-Series A startups trying to solve problems in this market. We have not yet made an investment in any of the startups in this market.

In the rest of this post we will attempt to;

  • Describe the ocean freight shipping market,
  • Discuss its market structure,
  • Describe the economics of operating within the market,
  • Describe and discuss the opportunities that startups are pursuing, and finally we
  • Discuss some threats such startups might encounter.

Writing this post is primarily an exercise in learning more about the ocean freight shipping market in order to be better equipped for the conversations we are currently having, and conversations we may have in the future, with startups building products for this market. If we have missed anything please let us know – we lack the expertise and knowledge of industry insiders, but we are willing to invest time in learning. If you are building a seed-stage startup in this market we would love to hear from you. If there are startups in this market we have not heard of yet, we would love to know that too. You can leave a comment in the comments section below, or you can email us directly;

  • Brian – brian@kecventures.com, or
  • John – johna@kecventures.com.

Lastly, we should point out that how we think about the market may not line up precisely with how industry insiders think about it. However, our purpose is to understand the landscape in sufficient detail to become intelligent investors in startups that have set out to solve problems for this market.

What is Ocean Freight Shipping?

Ocean freight shipping comprises the complex set of activities involved in transporting goods of all kinds from producers in one country to consumers in another country, where the two countries are separated by an ocean or a sea.

We have previously discussed freight trucking, and so in this post, we will focus on the maritime-only portion of the activities that surround ocean freight shipping. In the discussion that follows note that there is a blurring of the lines, somewhat, between the categories . . . Sometimes one category can morph into another, and vice versa . . . For example, a containership might be used to transport a comparatively small amount of bulk cargo.

The market may be segmented as follows;

Container Ships: Most merchandise that is transported by ocean freight travels by container ship. Container ships carry their cargo in reusable, standardized 20- or 40-foot long containers that are designed to be easily transferred from the ship to a truck or train without the need to access the cargo directly. The freight capacity of a cargo ship is described in twenty-foot equivalent units (TEUs).

Liner shipping describes the portion of the maritime shipping market that adheres to fixed schedules on regular routes. According to the World Shipping Council there are 500 liner shipping services currently in operation, most in the form of container shipping, accounting for 60% or $4 trillion worth of goods each year. 2See: http://www.worldshipping.org/about-the-industry/global-trade. Accessed Dec. 3, 2016.

Container ships transport general cargo, or cargo which is poorly suited for bulk cargo shipping operations but which is well suited for containerization. Most general cargo is now transported by containerships.

The chart below shows that there has been relatively steady growth in the worldwide volume of merchandise transported by container ships since 1980. 3This statistic represents the volume of international seaborne trade carried by container ships from 1980 through 2014. Globally, seaborne containerized cargo amounted to around 1.5 billion tons loaded in 2013.

Statistic: International seaborne trade carried by container ships from 1980 to 2014 (in million tons loaded) | Statista

Statistic: Projected global container market demand growth between 2003 and 2018 | Statista

Bulk Carriers: Bulk carriers transport merchandise that cannot be containerized – mainly raw materials like timber, coal, cement, grain, iron ore, etc. Bulk carriers are equipped with special machinery to aid in the handling of this type of merchandise.

Bulk cargo comes in the form of dry bulk or liquid bulk. Liquid bulk is transported using tankers. Often, bulk cargo is transported in full shiploads.

The chart below shows that there has been consistent growth in the worldwide volume of merchandise transported by bulk carriers since 1980. 4The statistic shows the volume of bulk materials shipped by sea from 1970 to 2008 in billion ton-miles. In 2008, 11.2 trillion ton-miles of main cargo were shipped worldwide.”Main cargo” goods include wheat, corn, barley, oats, rye, sorghum, and soybeans.

Statistic: Extent of global maritime trade with bulk goods from 1970 to 2008 (in billion ton-miles) | Statista

Tankers: Tankers are similar to bulk carriers, but are designed specifically for the transportation of crude oil and related products. Tankers are classified according to their deadweight capacity (DWT), with the smallest size group being 10,000 – 19,999 DWT and the largest being 200,000+ DWT. Tankers are also categorized according to the products they carry, crude or product. Based on The Tanker Register 2016 by Clarkson Research, the American Association of Port Authorities estimates that as of January 1, 2016;

  • There are 6,085 ships currently in service in the world tanker fleet with an average DWT of 86,211.
  • There are another 945 tankers on order with an average DWT of 106,408.

The chart below shows the amount of crude oil that is transported by the world’s tankers.

Statistic: Transport volume of crude oil in global seaborne trade from 2009 to 2015 (in million metric tons) | Statista

Specialist Ships: These are ocean-faring vessels designed to function in support of other types of maritime vessels or to perform activities related to specific industries. For example, an ocean-going vessel that’s been equipped to transport entire shiploads of motor cars from Asia to North America would fit this category – ships designed to carry cars are described as roll-on/roll-off (RoRo) ships.

A Container Ship | Image Credit: Helmut Jungclaus via Pixabay

Decades later, when enormous trailer trucks rule the highways and trains hauling nothing but stacks of boxes rumble through the night, it is hard to fathom just how much the container has changed the world.

– Levinson, Marc (2016-04-05). The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger (p. 1). Princeton University Press. Kindle Edition.

Taken together, bulk carriers, tankers, and some specialized ships comprise the tramp shipping segment of the market. The tramp trade describes cargo moved by ships that do not have fixed schedules or make planned port calls. These ships are usually engaged on a contract basis for the transport of commodities, namely crude oils, product (or refined) oils, major dry bulks (those comprising greater than two-thirds of the world dry bulk trade such as iron ore, coal, and grains) and minor dry bulk (those comprising the remainder of the bulk trade such as steel products, forest products, cements, and non-grain agricultural products like sugar).
The three types of charters, or contract under which a shipper can engage a tramp ship, in order of popularity, are;

  • voyage charters, under which the ship and its crew is contracted for a particular trip or set of destinations,
  • time charters, under which the ship and its crew is contracted for a specified period of time, and
  • demise charters, under which the ship is contracted but the shipper is responsible for staffing.

The diagram below is a self explanatory depiction of the organization of the shipping market. It is taken from the 3rd edition of Martin Stopford’s Maritime Economics.

Source: Stopford, Martin. Maritime Economics, 3rd Edition.

How is The Ocean Freight Shipping Industry Structured?

Shippers: Any entity that pays to have its cargo shipped.

Freight Forwarders: A freight forwarder functions as a consultant to shippers by arranging and taking care of the details related to the import and export of a shipper’s goods. A freight forwarder does not physically ship cargo. Instead, the freight forwarder is a broker who uses extensive industry knowledge, established relationships, knowledge of the law, and experience to get the best deal possible given constraints set by by the shipper. According to the October 2016 update of the industry profile of Freight Forwarding Services published by First Research, the industry generates annual revenues of approximately $260 billion. 5First Research Industry Profile: Freight Forwarding Services, 10.17.2016. Accessed online via New York Public Library SIBL Branch on Jan. 5, 2017.

Non-Vessel Operating Common Carriers (NVOCCs): An NVOCC is similar to a freight forwarder. However, an NVOCC may go an extra step and physically handle cargo on behalf of shippers in the sense that they will load cargo onto containers that then get shipped by ocean carriers. NVOCC’s generally will accept partial container loads for shipping on the shipper’s behalf. An NVOCC may own or lease its own containers, but does not own any ships.

Ocean Carriers: These are the companies that actually own the ships in which cargo is transported from one place to another. The relationship between the carrier and the shipper is governed by the bill of lading (B/L), a contract that documents the composition of the cargo, the ownership of the cargo, the terms of the agreement to transport the cargo, and eventual delivery from the carrier to the shipper. 6A bill of lading can be non-negotiable or negotiable. Negotiable bills of lading can be used as the basis for various transactions while the goods are in transit.

The following chart outlines the world’s leading container ship operators.

Statistic: The world's leading container ship operators as of December 5, 2016, based on total number of ships | Statista

Other participants in the wider maritime freight market include customs authorities, warehouse operators, freight trucking companies, and various entities that are the end customers of the shippers. For example, Best Buy might be the end-customer for shipments of Apple’s iPhones from Foxconn’s manufacturing facilities in China.

As we have stated previously, liner shipping describes the portion of the maritime shipping market that adheres to fixed schedules on regular routes. Charter shipping occurs on a just-in-time basis, usually brokered through the services of a freight-forwarder or an NVOCC on behalf of the shipper. The term “tramping” is used within the industry to refer to charter service.

Oil companies often own or lease the tankers that they use to transport their goods around the world. For example; BP Shipping was established in 1915, and now operates BP’s international fleet of 49 ships made up of tankers and liquid bulk carriers. 7Source: http://www.bp.com/en/global/bp-shipping/careers.html. Accessed; Jan 23, 2017.

One anecdote we heard suggests there may be at least as many as a dozen intermediaries involved in the process of getting one shipment of goods from one point to another. However, it is not clear if this is broadly true across the industry or of it applies only to certain segments of the market.

What Are The Economics of The Ocean Freight Shipping Industry?

According to the United Nations Conference on Trade and Development (UNCTAD); 8Report by the UNCTAD Secretariat, Review of Maritime Transport 2013.

“In general terms, the demand and the supply of maritime transport services interact with each other to determine freight rates. While there are countless factors affecting supply and demand, the exposure of freights rates to market forces is inevitable. Cargo volumes and demand for maritime transport services are usually the first to be hit by political, environmental and economic turmoil. Factors such as a slowdown in international trade, sanctions, natural disasters and weather events, regulatory measures and changes in fuel prices have an impact on the world economy and global demand for seaborne transport. These changes may occur quickly and have an immediate impact on demand for maritime transport services. As to the supply of maritime transport services, there is generally a tendency of overcapacity in the market, given that there are no inherent restrictions on the number of vessels that can be built and that it takes a long time from the moment a vessel order is placed to the time it is delivered, and is ready to be put in service.

Therefore, maritime transport is very cyclical and goes through periods of continuous busts and booms, with operators enjoying healthy earnings or struggling to meet their minimum operating costs.”

In Maritime Economics, Martin Stopford further illustrates the economic and financial challenges that shipping companies must contend with when he says; 9Martin Stopford, Maritime Economics, 3rd Edition, Routledge, 2009.

“. . . the challenge is to create sufficient financial strength when times are good to avoid unwelcome decisions such as selling ships for scrap when times are bad. It is the company with a weak cashflow and no reserves that gets pushed out during depressions and the company with a strong cashflow that buys the ships cheap and survives to make profits in the next shipping boom. It is not therefore the ship, the administration, or the method of financing that determines success or failure, but the way in which these are blended to combine profitability with a cashflow sufficiently robust to survive the depressions that lie in wait to trap unwary investors.”

In order to develop some insight on which to base our understanding of the economics of ocean freight shipping we have relied on the following sources; 10Please let us know if there are more current references on the topic we did not find.

  1. Konstantinos Gkonis and Harilaos Psaraftis – Some Key Variables Affecting Liner Shipping Costs,
  2. Harilaos Psaraftis, Dimitrios Lyridis, and Christos Kontovas – The Economics of Ships, Chapter 19 in The Blackwell Companion to Maritime Economics, and
  3. Martin Stopford – Maritime Economics, 3rd Edition, Chapters 6, 7, and 8.

Shipping revenues are affected by the interplay between cargo capacity, productivity, and freight rates. Where revenue increases as each of these factors is maximized by the shipping company.

The costs of operating a shipping fleet are determined by the interaction between operating costs – including periodic maintenance costs; the costs of maintaining the sea-worthiness of the ships in the fleet according to regulatory requirements and the shipping company’s own policies, voyage costs, and cargo handling costs.

Lastly, ship owners have to worry about capital costs which are a function of the mechanism by which the fleet has been financed.

Stopford points out that the shipping industry has not adopted an internationally accepted standard classification of costs, making any discussion about costs in the shipping industry confusing and unnecessarily difficult.

The following variables also play a crucial role in determining the profitability of a shipping fleet operator;

  • The mix of different types of ships within the fleet,
  • The age of each ship in the fleet – newer ships are typically more profitable to operate than older ships,
  • The capacity of each ship in the fleet – bigger ships are generally more profitable to operate than smaller ships as long as the bigger ships do not impose disproportionately higher operating and voyage costs on the fleet operator,
  • The fuel efficiency of each ship in the fleet – higher fuel efficiency lowers voyage costs, and related to fuel efficiency is the operating speed of each ship in the fleet,

To further ground our understanding of the economic realities of the ocean freight shipping market, the following data and diagrams from Stopford’s book are helpful.

By comparing average earnings per day with the standard deviation of daily earnings, we get a sense of the extreme economic and financial uncertainty that plagues operators of shipping fleets.

Source: Stopford, Martin. Maritime Economics, 3rd Edition.

In the table below, notice that one way to guard against the revenue volatility that’s evident in the data above is for fleet operators to diversify the types of ships that they buy to compose a fleet. For example, one such fleet might be made up by combining VLCC, Panamax, Handymax, MPP 16kdwt, and Containerships in different proportions that add to 100%. Basically, the fleet operator has to invest in a diversified portfolio of ships in order to protect the fleet from the probability of failure or bankruptcy associated with any one specific ship or class of ships.

Source: Stopford, Martin. Maritime Economics, 3rd Edition.

The diagram below outlines the macroeconomic factors that influence supply and demand in the shipping market. Note that there are several factors over which the fleet operator has no control.

Source: Stopford, Martin. Maritime Economics, 3rd Edition.

The diagram below outlines the flow of cash and services between the 4 primary segments of the shipping market; The freight market, the shipbuilding market, the sale and purchase market, and the demolition market.

Source: Stopford, Martin. Maritime Economics, 3rd Edition.

Sabeen Firozali (@sabeenfirozali) is a Vice President at Comerica Bank in New York, where she invests debt capital in technology and life sciences startups. Her experience as a debt investor spans both public and private markets and across many industries, including technology, healthcare, industrials, energy and consumer. She sent us the following comment, which provides additional context to the economics of the ocean freight shipping market;

“I used to cover shippers like Overseas Shipholding Group (OSG) back when I did distressed debt investing. These companies have pretty complex capital structures (For example; each ship is in a different entity). That required a thorough analysis of the assets and future earnings potential from those assets. In 2012 when I was covering this industry, we were really worried about low spot rates for everything from VLCCs to Panamaxes and also a deluge of fleet supply keeping prices low.

More recently; These tankers are currently levered with debt/EBITDA ratios anywhere from 7x for Teekay Tankers Ltd. (TNK), and  Tsakos Energy Navigation Limited (TNP) to about 3.5x for OSG, and Frontline Ltd. (FRO). That’s why operating efficiencies are so important, because financial leverage is so high. The industry added a lot of capacity between 2003 and 2010 when spot rates were higher (in expectation of higher returns). Now spot rates are much lower and there’s too much supply. However, the supply is new – 70% of the supply won’t need to be scrapped for another 10 – 12 years. It’s a classic supply-demand misbalance resulting in lower revenues. Combine that with high interest payments and you have a scenario where every dollar operating cost elimination really helps the bottom line.”
She sent us this chart to illustrate the point about capacity.
Source: Institute of Shipping Economics and Logistics

This is a double edged sword for startups selling into the market; on one hand shipping companies are highly motivated to find and pay for products that help them operate more efficiently. On the other hand, in the worst case scenario the ships might be scrapped in a desperate bid by some incumbents to avoid bankruptcy. This is not an uncommon occurrence since each ship is an independent entity onto itself, and can be allowed to fail without necessarily putting the holding company at risk.

What Opportunities are Startups Pursuing?

As we alluded to in our post on freight trucking startups, supply chain and logistics is a big market . . . and there are many startups building products to serve that market. This market map by CB Insights lays out the landscape in sufficient detail to provide a sense of the breath of the market for supply chain and logistics software. You can find the accompanying blog post here.

CB Insights’ Supply Chain and Logistics Tech Market Map. Nov. 30, 2016.

Given how far removed ocean freight shipping is from the day to day experience of most people, it should not be surprising that there is a much smaller number of startups building products for the ocean freight shipping market.

Before we get to the startups, the following data and charts from CB Insights helps to paint of the level of interest among investors. Compiling data specifically focused on maritime startups would have been an incredibly tedious and time consuming process. So, we are using aggregate data as a proxy.

Investments in Startups Building Marketplaces

The next three charts focus on startups pursuing marketplace business models, and reflect investments by institutional venture capitalists and angel investors only. Corporate VCs are excluded, for the most part . . . The database query might have failed to pick up a couple. The data is as of Jan. 30, 2017.

As you can see, funding amounts peaked in 2015 while the number of discrete investments peaked in 2016. One way to interpret this is that, to some extent, the 2016 trend in number of deals may reflect a case of “me-too” investments driven by social-proof bias.

Investment Activity – Marketplaces – Venture Capital and Angel Investors ex Corporate VCs, Past 5 Years

Comparing measures of central tendency in the data, notice that there is dramatic jump in the average deal size in Q2 2015 and Q3 2015, but this trend is not reflected in the median deal size.

Investment Activity – Marketplaces – VCs and Angel Investors ex Corporate VCs, Past 5 Years

The deals below largely account for the spike in aggregate funding amounts, and correspondingly, in average deal sizes for Q2 2015 and Q3 2015, respectively, in the chart above.

Marketplace Q2 2015
  • Wish raised $500M from DST Global, Founders Fund, GGV Capital and JD.com
  • Zhubajie raised $418.6M from Chongqing New North Zone Goverment Investment Fund and Cybernaut Growth Fund
  • Funding Circle raised $150M from Baillie Gifford & Co, BlackRock, DST Global, Sands Capital and Temasek Holdings
  • Wallapop raised $100M from Accel Partners, BlackPine Private Equity Partners, Eight Roads Ventures, Insight Venture Partners, NextView Ventures, Northzone Ventures and Vostok New Ventures
Marketplaces Q3 2015
  • Social Finance raised $1bn  from Baseline Ventures, DCM Ventures, Institutional Venture Partners, Renren Lianhe Holdings, RPM Ventures, Softbank Group, Third Point and Wellington Management
  • Thumbtack raised $125M from  Baillie Gifford, capitalG, Sequoia Capital and Tiger Global Management

The next chart gives you a sense of the investors who are most actively investing in startups that are building marketplace business models.

Investment Activity – Marketplaces – VCs and Angel Investors ex Corporate VCs, Past 5 Years

Investments in Startups in Supply Chain and Logistics

The next three charts focus on startups pursuing business models in the Supply Chain and Logistics market, and reflect investments by institutional venture capitalists and angel investors only. Corporate VCs are excluded, for the most part – you’ll notice that the query missed a couple. The data is as of Jan. 30, 2017.

Investment Activity – Supply Chain and Logistics – Venture Capital and Angel Investors ex Corporate VCs, Past 5 Years

Comparing measures of central tendency in the data, notice that there is dramatic jump in the average deal size in Q2 and Q4 of 2014, but this trend is not reflected in the corresponding median deal size in each period.

Investment Activity – Marketplaces – Venture Capital and Angel Investors ex Corporate VCs, Past 5 Years

The deals below largely account for the spike in aggregate funding amounts, and correspondingly, in average deal sizes for Q2 2014 and Q4 2014, respectively, in the charts above.

SC&L Q2 2015
  • New Dada raised  $100M from DST Global, Sequoia Capital China & Greenwoods Asset Management
SC&L Q4 2015
  • New Dada raised  $300M from DST Global & Sequoia Capital China
  • Grofers raised $120M from Apoletto, Sequoia Capital India, SoftBank Group & Tiger Global Management

The next chart gives you a sense of the investors who are most actively investing in startups that are building products for the supply chain and logistics market.

Investment Activity – Marketplaces – Venture Capital and Angel Investors ex Corporate VCs, Past 5 Years

Below is a sample of some of the startups building technology products specifically for the ocean freight shipping market. You may recognize some of them in the market map from CB Insights. There is no particular rationale for the order in which we have arranged them here. Descriptive summaries are either copied directly, or based on information, from each startup’s website. Other data presented below is based on information collated by CB Insights, Traxn, Crunchbase, or Mattermark – with CB Insights being the source that appeared to have the most complete information, where it was available at all, and that data is current as of Jan. 25, 2017.

There are undoubtedly tech startups in this market that we have not yet heard about. Let us know about any we have omitted, but which you feel we should be aware of. Full disclosure, we have done some preliminary due diligence on a couple of the startups on this list.

Fleet

  • Summary: An online marketplace for international freight.
  • Year Established: 2014
  • Location: Portland, OR
  • Aggregate Funding: $4,000,000
  • Representative Investors: 1517 Fund, GrowthX, Hunt Technology Ventures, NFQ Ventures

Xeneta

  • Summary: A real-time price-benchmarking and market intelligence platform for international shipping.
  • Year Established: 2012
  • Location: Oslo, Norway
  • Aggregate Funding: $8,470,000
  • Representative Investors: Point Nine Capital, Creandum, Alliance Venture

Holland Container Innovations

  • Summary: Developed, and markets, foldable shipping containers in order to reduce the cost of empty repositioning.
  • Year Established: 2008
  • Location: Delft, Holland
  • Aggregate Funding: Unavailable
  • Representative Investors: CARU Containers

Kontainers

  • Summary: Makes it easy to book and track container shipments.
  • Year Established: 2014
  • Location: London, UK and New York, NY
  • Aggregate Funding: $1,300,000
  • Representative Investors: EC1 Capital, Northstar Ventures, Partech Ventures

Flexport

  • Summary: A licensed freight forwarder that uses people and software to manage the complexity of international trade.
  • Year Established: 2013
  • Location: San Francisco, CA
  • Aggregate Funding: $91,600,000
  • Representative Investors: Y Combinator, Founders Fund, First Round Capital, Bloomberg Beta, Felicis Ventures

iContainers

  • Summary: A web platform with which importers and exporters compare rates in real time and manage their maritime shipments quickly and easily from beginning to end.
  • Year Established: 2007
  • Location: Barcelona, Spain
  • Aggregate Funding: $8,100,000
  • Representative Investors: Kibo Ventures, Serena Capital, GrupoRomeu

FreightOS

  • Summary: An online marketplace for international freight.
  • Year Established: 2011
  • Location: Hong Kong
  • Aggregate Funding: $27,700,000
  • Representative Investors: Aleph, OurCrowd, MSR Capital

Cargohound

  • Summary: An online marketplace for international freight.
  • Year Established: 2012
  • Location: Sydney, Australia
  • Aggregate Funding: $590,000
  • Representative Investors: Unavailable

Haven Inc

  • Summary: Connects commodity traders, food producers, and shippers to thousands of logistics providers through one platform.
  • Year Established: 2014
  • Location: San Francisco, CA
  • Aggregate Funding: $13,800,000
  • Representative Investors: Data Collective, First Round Capital, Spark Capital

CoLoadX

  • Summary: A digital ocean freight procurement platform built by freight forwarders, NVOCC’s and logistics service buyers.
  • Year Established: 2015
  • Location: New York, NY
  • Aggregate Funding: $240,000
  • Representative Investors: Entrepreneurs Roundtable Accelerator, other undisclosed investors

Octopi TOS

  • Summary: A modern, web-based Terminal Operating System (TOS) built for small to medium container terminals.
  • Year Established: Unavailable
  • Location: Miami, FL
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

WindWard

  • Summary: Provides its customers with real-time visibility into the location of ocean freight as well as what’s happening at sea while the freight is in transit.
  • Year Established: 2010
  • Location: Tel Aviv, Israel
  • Aggregate Funding: $15,800,000
  • Representative Investors: Horizons Ventures, Aleph.

Hive Maritime

  • Summary: Optimizes global trade logistics through improved route management and increased situational awareness.
  • Year Established: Unavailable
  • Location: Cambridge, MA
  • Aggregate Funding: Unavailable
  • Representative Investors: MassChallenge

SimpliShip

  • Summary: A dynamic online marketplace connecting international shippers with NVOCC’s and Freight Forwarders.
  • Year Established: 2014
  • Location: Rochester, NY
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

Shippabo

  • Summary: Puts ocean shipping in your hands. Get hassle free shipping rates and schedule your next shipment instantly.
  • Year Established: 2014
  • Location: Los Angeles, CA
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

AlphaShips

  • Summary: Sources and underwrites maritime loans, that are then offered to accredited and institutional investors.
  • Year Established: 2015
  • Location: Los Angeles, CA
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

New York Shipping Exchange

  • Summary: A market place for derivative contracts – forward contracts, for the container shipping market.
  • Year Established: 2015
  • Location: Montclair, NJ
  • Aggregate Funding: $510,000
  • Representative Investors: Unavailable

Nautilus Labs

  • Summary: Nautilus securely collects, reports on, and analyses raw sensor data generated on commercial ships.
  • Year Established: 2016
  • Location: Brooklyn, NY
  • Aggregate Funding: $780,000
  • Representative Investors: Root Ventures, Bre Pettis, Marina Hadjipateras

MARSEC

  • Summary: A multimodal transport optimization platform applying Industrial Internet of Things and Big Data Analytics to maritime operations.
  • Year Established: 2014
  • Location: Palo Alto, CA
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

ClearMetal

  • Summary: Predictive logistics software for operations in the container-shipping market.
  • Year Established: 2014
  • Location: San Francisco, CA
  • Aggregate Funding: $3,000,000
  • Representative Investors: Innovation Endeavors, New Enterprise Associates, Skyview Capital

AKUA

  • Summary: A multimodal transport optimization platform applying Industrial Internet of Things and Big Data Analytics to bring real-time visibility to cargo owners.
  • Year Established: Spun-out from CyberPoint in April 2016
  • Location: Baltimore, MD
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

Quotiss

  • Summary: Freight management software for freight-forwarding companies. Automates 99% of the freight management process, and automates freight quotes.
  • Year Established: 2016
  • Location: Warsaw, Poland
  • Aggregate Funding: Unavailable
  • Representative Investors: Techstars Berlin

Blockfreight

  • Summary: Blockchain solutions for the shipping market.
  • Year Established: 2016
  • Location: Melbourne, Australia
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

Navarick Corp

  • Summary: Software solutions and data products for the oil industry.
  • Year Established: 2008
  • Location: Vancouver, BC
  • Aggregate Funding: $1,000,000
  • Representative Investors: Unavailable

MainDeck.io

  • Summary: First platform covering the entire dry-docking process, from first inspection to final report.
  • Year Established: 2016
  • Location: Oslo, Norway
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

OpenSea Pro

  • Summary: A marketplace for chartering ships and finding cargo based on the user’s location.
  • Year Established: 2014
  • Location: Scotland
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

Stage 3 Systems

  • Summary: Software for the shipping industry.
  • Year Established: 2010
  • Location:Vancouver, BC
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

eSSDOCS

  • Summary: Paperless trade solutions to automate and accelerate trade operations and finance.
  • Year Established: 2005
  • Location: Valleta, Malta
  • Aggregate Funding: $2,520,000 Debt Financing
  • Representative Investors: Unavailable

PortCall.com

  • Summary: A port or terminal operating system.
  • Year Established: 2015
  • Location: Unavailable.
  • Aggregate Funding: Unavailable
  • Representative Investors: PortXL

SailRouter

  • Summary: An all in one software solution for reducing fuel consumption for merchant ships.
  • Year Established: 2016
  • Location: Rotterdam, Netherlands
  • Aggregate Funding: Unavailable
  • Representative Investors: PortXL

Shipamax

  • Summary: Shipamax enables you to internally share fleet openings & the commercial status of each ship. Details can be accessed in real-time by the whole team, across multiple locations.
  • Year Established: 2016
  • Location: London, England
  • Aggregate Funding: Unavailable
  • Representative Investors: Dynamo Accelerator & Fund

PortXL

  • Summary: PortXL is an accelerator program focusing on port related industries offering an ecosystem of founders, corporate partners, investors and mentors that support and accelerate the entrepreneurial journey.
  • Year Established: 2015
  • Location:Rotterdam, Netherlands
  • Aggregate Funding: Unavailable
  • Representative Investors: Unavailable

While we believe there is a smaller number of startups building products for the ocean freight market, we almost certainly have missed more than we have been able to capture. We are eager to hear about startups we have missed, or to hear about the ideas that people are exploring and hope to launch in the near future.

Everyone loves containers. They see them. They get them. It makes sense. But when you look at number of vessels, container ships are only 10%. They’re inconsequential to bulk, crude, gas/chemical, and cargo. Much more interesting markets to be exploring in my personal opinion.

– Anthony DiMare, co-founder/CEO, Nautilus Labs (via email)

Threats and Opportunities

On a relative basis, if software and automation are “eating the world” as it were, one might argue that the ocean freight shipping market failed to read the memo. However, it ought to be evident from the preceding discussion that there is a small band of entrepreneurs out to change that state of affairs.

While they spare no effort to that end, market analysts at Lloyd’s Register, University of Strathclyde’s Department of Offshore, and QinetiQ have some ideas about what the industry might encounter between now and 2030. The Global Maritime Trends 2030 report is worth reading if this market if any interest to you at all. If that seems too much there’s a more easily digestible summary. 11Accessed; Feb. 5, 2017.

The report considers three scenarios and how each might be affected by demography, the global economy, demand for resources, and disruptive events. While the rest of the report is very interesting, for the purpose of this study we will highlight the events that the report’s authors believe could be disruptive to the shipping market in general, and hence to the ocean freight market.

  1. Russia joins NATO, and the balance of geopolitical power shifts quite dramatically.
  2. The United States Dollar loses its reserve currency status in a disorderly manner, causing upheavals in the global economy.
  3. There is a major pollution accident in the Artic, causing supply disruptions as well as significant changes to shipping routes.
  4. Geopolitical changes in the Middle East lead to conflict and constrain energy supplies.
  5. Unforeseen technological disruptions make formerly popular modes of marine freight shipping obsolete.
  6. A global economic and geopolitical collapse causes extreme disruptions to trade and commerce.

The technological disruptions that the authors worry most about are;

  1. Clean coal technologies, which have a significant impact of the amount of petroleum related products transported around the world by ocean tankers.
  2. Biofuels become sophisticated and efficient enough to have a significant impact on volume of hydrocarbon-based fuels that the world consumes, leading to a steep decrease in the export and import of petroleum related products.
  3. Deep water exploration for crude oil is curtailed so much that there is a collapse in the tanker market,
  4. Robotics advances rapidly enough to change the manufacturing patterns for various types of consumer goods in ways that adversely affect international trade via containership since large volumes of consumer goods that were previously imported from China and other markets in Asia are now produced in fully automated factories in the markets that were the biggest importers of such good. The containership market suffers significant losses.
  5. 3D printing advances to the point where high end products and goods can be manufactured using this method. Together with the large-scale adoption of automation technologies in factories and the use of robots described above, marine trade by containership takes a big hit. Developing markets start a painful transition away from low-paying low-skill manufacturing jobs to high-skill jobs.
  6. Autonomous ships start to make an appearance in the commercial sector, after being tested for military use and gaining some adoption.

Before we get to 2030, however . . . There are more immediate issues startups and investors operating in this market have to be aware off. Below we highlight some of them.

  1. Industry turmoil during times of frailty in the global economy can have a disproportionate impact on startups that sell to customers in this market because the customer base is highly sensitive to declines in international trade. Demand for the products and services that startups selling to this market will fluctuate with the business cycle. Industry consolidation is a concern. Also, consolidation within the industry during periods of declining trade may materially shift the balance of power within the industry in ways that could be disadvantageous to startups selling products and services for the shipping market.
  2. Business practices within the ocean freight shipping market are not as transparent as the practices in other markets that startups often engage with. For example, historically, the industry has maintained the practice of registering ships under a foreign flag – a “flag of convenience”, that differs from the nationality of the ship’s owners. Opponents of this practice argue that it encourages bad behavior within the industry since ships are often registered in jurisdictions with very lax regulations – Panama and Liberia are among the most popular, for example. 12See: List of flags of convenience – Wikipedia.
  3. Price negotiations between shippers and carriers are confidential. This can be problematic if a startup’s revenue model is dependent on knowing this information.
  4. Piracy is an ongoing concern for the industry.
  5. Employees in the maritime freight industry in the United States are heavily unionized.
  6. Threats from tech sector incumbents are a real concern.
    • Recent articles in MIT Technology Review, Bloomberg, and the Wall Street Journal discuss Amazon’s entry into supply chain management. It has established new sea and air cargo shipping operations, including registering Amazon China with the Federal Maritime Commission. That may be a possible first-step on the path to becoming a full-fledged freight forwarder as is explained in this blog post by Ryan Petersen at Flexport. The threat is such that journalists who follow that market feel that UPS and FedEx may also be under pressure if Amazon succeeds.
    • Alibaba has also been making forays into this market. Most recently it has caused a splash with the news that it is partnering with Maersk, the world biggest shipping company, to sell cargo space on containerships operated by Maersk. This article published by Quartz says: “The service reduces dependency on some tasks performed by freight forwarders—middle-men between merchants and shipping lines—and streamlines the export process for merchants. Users can lock in cargo space on certain routes by pre-paying their deposit, Maersk told Reuters. Freight forwarders’ services, such as documentation and customs clearance, can be provided through the OneTouch platform, Maersk said.” The rest of the article is worth reading just to get a sense of the scale of Alibaba’s ambitions for this market. 13This article on the Maersk-Alibaba tie-up provides more context, and some commentary from Maersk executives on how they are thinking about their market; http://www.lloydsloadinglist.com/freight-directory/news/Maersk-Alibaba-tie-up-%E2%80%98no-major-threat-to-forwarders%E2%80%99/68345.htm#.WJog17YrLfA

We believe that entrepreneurs succeed when they take advantage of a threat or opportunity that others do not notice. Are there any we have missed? If yes, please tell us. 14One opportunity I did not find discussed is the application of industrial internet of things technologies to engine maintenance and monitoring in the ocean freight shipping market. This was somewhat surprising. This article from Deloitte University Press discusses broad IoT opportunities in transport and logistics.

Amazon Enters Shipping – MIT Technology Review

Automatic Identification System (AIS) – A Key Technology?

The overwhelming majority of maritime carrier vessels have their positions, speeds, and trajectories tracked by Automatic Identification Systems (AIS). AIS systems are usually composed of Very High Frequency (VHF) transmitters and receivers, GPS receivers, maritime electronic links, vessel sensors and display systems. AIS systems are ubiquitous because of Regulation 19 of the International Convention for the Safety of Life at Sea (SOLAS) Treaty. SOLAS was enacted in 1974 by the International Marine Organization (IMO), the United Nations special agency tasked with regulating shipping for its 172 Member and three Associate countries. The purpose of AIS is to provide safety at sea by increasing visibility and capacity to plan around surrounding vessels. The regulation applies to any ship with greater than 300 tonnes of gross tonnage registered in an IMO country.

Traditional applications of AIS include collision avoidance, fleet monitoring, security, search and rescue, and cargo tracing. Should startups begin to experiment with ways to disrupt the maritime freight industry, AIS could prove to be a useful system on which they can build.

Transparency is the first step toward building a highly predictable marine shipping infrastructure. Transparency into a ship’s location allows carriers and brokers to more accurately estimate the arrival of cargo. There is still a ways to go towards that end. In 2013, annual container lines schedule reliability, a measure of the percentage of ships that arrive within their delivery window, fell between 67% and 83%.

Further, the effects of weather and ocean currents complicate the estimability of vessel arrivals. However, we believe that maritime freight would serve to benefit from;

  • Systems that would help carriers more accurately assess transit times and eliminate delay days, 
  • Systems that can use AIS data to draft charter-parties and serve the spot market, 
  • Technologies that bridge communication between maritime and trucking companies so that both may better serve shippers, and
  • Services that lend door-to-door transparency to cargo for shippers.

AIS infrastructure can provide a foundation to future advances in cargo transparency and freight accessibility for shippers.

A depiction of AIS – Source: Zinnos, Inc.

Wrapping Things Up

Writing this post was primarily an exercise in learning more about the ocean freight shipping market in order to be better equipped for the conversations we are currently having, and conversations we may have in the future, with startups building products for this market. If we have missed anything you feel is important please let us know.

We know how frustrated founders feel when early stage investors (a) do not know anything about a market in which they profess to wanting to make investments in, and (b) make no effort to learn enough about that market in order to have substantive discussions with the founders about what the founders hope to accomplish, and the merits of an investment in the specific startup that founder is building. We do not want to be that investor, we believe in doing our homework.

If you are building a seed stage startup in this market we would love to hear from you. If there are early-stage startups we have not heard about yet, we would love to know that too. If you invest in or have invested in seed-stage startups pursuing any of the opportunities we have described above, or others in the ocean freight shipping  market, we’d love to collaborate with you on future investments. If you are a shipping industry insider . . . We’d love to hear from you as well.

You can leave a comment in the comments section below, or you can email us directly;

One last thing. We’d like to express our thanks and appreciation to Britie Sullivan and her teammates at CB Insights for all their help obtaining data that we could not easily gather on our own for this article, and also for the freight trucking article before this. She answers our questions patiently, and often gives us more than we expect. This article is much better because of the data and insights she helped us obtain.

 Additional Reading

Industry Links

Update: February 8, 2017 at 19:47 to include comments from Sabeen Firozali, and to add footnote about IoT applications to engine Mx.

Update: February 9, 2017 at 05:19 to include Nautilus Labs and MARSEC to list of startups, comment from Anthony DiMare, and link in footnotes to IoT in transportation and logistics article from Deloitte University Press.

Update: February 9, 2017 at 11:16 to include AKUA and ClearMetal, also edit Nautilus Labs’ summary.

Update: February 9, 2017 at 18:51 to correct Sabeen Firozali’s comment. It originally referred to interest rates instead of spot rates. Spot rates were higher in 03-10 and they are directly tied to revenue; higher spot rates lead to higher revenues. When spot rates were high, lots of companies invested in building ships.

Update: February 9, 2017 at 19:31 to correct the aggregate funding amount raised by CoLoadX from $40,000 to $240,000 based on information provided by the co-founders.

Update: June 20, 2017 at 17:22 to fix date typo in updates; change “2016” to “2017”.

References

I settled on this definition after reading the work of Steve Blank and Paul Graham.
See: http://www.worldshipping.org/about-the-industry/global-trade. Accessed Dec. 3, 2016.
This statistic represents the volume of international seaborne trade carried by container ships from 1980 through 2014. Globally, seaborne containerized cargo amounted to around 1.5 billion tons loaded in 2013.
The statistic shows the volume of bulk materials shipped by sea from 1970 to 2008 in billion ton-miles. In 2008, 11.2 trillion ton-miles of main cargo were shipped worldwide.”Main cargo” goods include wheat, corn, barley, oats, rye, sorghum, and soybeans.
First Research Industry Profile: Freight Forwarding Services, 10.17.2016. Accessed online via New York Public Library SIBL Branch on Jan. 5, 2017.
A bill of lading can be non-negotiable or negotiable. Negotiable bills of lading can be used as the basis for various transactions while the goods are in transit.
Source: http://www.bp.com/en/global/bp-shipping/careers.html. Accessed; Jan 23, 2017.
Report by the UNCTAD Secretariat, Review of Maritime Transport 2013.
Martin Stopford, Maritime Economics, 3rd Edition, Routledge, 2009.
Please let us know if there are more current references on the topic we did not find.
Accessed; Feb. 5, 2017.
See: List of flags of convenience – Wikipedia.
This article on the Maersk-Alibaba tie-up provides more context, and some commentary from Maersk executives on how they are thinking about their market; http://www.lloydsloadinglist.com/freight-directory/news/Maersk-Alibaba-tie-up-%E2%80%98no-major-threat-to-forwarders%E2%80%99/68345.htm#.WJog17YrLfA
One opportunity I did not find discussed is the application of industrial internet of things technologies to engine maintenance and monitoring in the ocean freight shipping market. This was somewhat surprising. This article from Deloitte University Press discusses broad IoT opportunities in transport and logistics.

“Liking” Facebook’s Business Model – The #EconomicMoats Remix

by

Facebook Employee Sign Hack: Pride 2015 (Image Credit: Facebook)
Facebook Employee Sign Hack: Pride 2015 (Image Credit: Facebook)

Note: I published “Liking” Facebook’s Business Model on December 26, 20011 at Tekedia. This article updates that discussion by incorporating developments since then. It also folds in discussion of the economic moats that Facebook has developed around its business. Large segments of this article are exactly identical to the post that was published by Tekedia in 2011.

Introduction

The primary purpose of this post was to demonstrate how one might apply the Business Model Canvas in trying to understand Facebook’s business model. Assuming we understand the business model, I then apply the Economic Moats framework to thinking about Facebook.

It is a fair critique to accuse me of playing “Monday-Morning Quarterback” since it is easy to pick on an extreme success like Facebook and use it as an example. However, from my perspective as an early stage venture capitalist who is basically teaching himself the trade that critique ignores at least one benefit of this kind of case study – mainly that it is useful for trying to recreate the path I might have followed in thinking about Facebook had I been introduced to Mark Zuckerberg in 2004 when he was raising his first outside capital from investors. Think of this as the self-taught early stage venture capitalists’ version of working in a science laboratory, trying to recreate the experiments and reproduce the results that have brought us the advances of the past. Such work is what lays the groundwork for original scientific discoveries in the future.

Also, I should point out that I do not have direct access to inside-information about Facebook’s early days. This case is constructed on the basis of information, reports, and data that are in the public domain.

Okay, with those disclaimers out of the way . . . On with our case study.

According to Michael Rappa; “In the most basic sense, a business model is the method of doing business by which a company can sustain itself – that is, generate revenue. The business model spells-out how a company makes money by specifying where it is positioned in the value chain.” Alex Osterwalder and Yves Pigneur say that; “A business model describes the rationale of how an organization creates, delivers and captures value.”

What problem does Facebook solve?

My son’s paternal grandparents live in Nigeria, as does his uncle – my younger brother. His aunt – my younger sister lives in Ghana. His grandfather has never met him, nor have his uncle and aunt. His grandmother paid him a visit for three months soon after he was born. He was only two months old when she visited.

I had been asking myself the question; “How can I ensure that his grandparents, his uncle, his aunt and other members of his extended family do not miss out on his childhood entirely?” My desire to answer that question in a comprehensive way helped me to overcome my objections to Facebook. I joined Facebook in November 2009.

Facebook enables its users to connect with one another through the company’s social networking online portal. Users connect socially with their “friends” in a “social-network” to share status updates, articles, videos, music, photographs and other content through Facebook.

Facebook’s users can interact with one another in a number of different ways:

  • Users can connect directly as “friends” – this allows the highest degree and freedom of interaction subject to privacy controls that each user can put in place to govern their activity on Facebook.
  • Users can connect to one another as subscribers/followers – this is a one-way connection. Subscribers will see and can comment on the public posts by the person to whom they have subscribed. This feature was a recent addition when I wrote the original post in 2011.
  • Users can interact with one another through Facebook Messenger, an instant messaging app that has evolved since the function was first introduced to Facebook’s users in 2008. 
  • Facebook acquired Instagram in 2012 Instagram built a social network for sharing photos.
  • Facebook acquired WhatsApp in 2014. WhatsApp is a mobile instant messaging app that is popular in developing markets.
  • Facebook acquired Oculus VR in 2014. Oculus VR is  a virtual reality technology startup. 

Founded in 2004, Facebook’s mission is to give people the power to share and make the world more open and connected. People use Facebook to stay connected with friends and family, to discover what’s going on in the world, and to share and express what matters to them.

– Source: Facebook, as of March 2016

The following list highlights some of Facebook’s features:

  • User profiles and homepages – users post status updates on their homepage or wall.
  • Messages, Chat and Social Hangouts (video chat).
  • Photos + Videos – users can tag one another in photos and videos.
  • Games + Apps – people can play games with one another, or share other information through specialized apps.
  • Groups and Pages – people can form a group or create a page for sharing information around an issue of interest.
  • Events – people can use Facebook to plan events and invite others to participate.
  • Credits – this is the virtual currency for transactions on Facebook.

Reports in the press suggest that Facebook has about 800 million active users around the world. An active user is a user who has returned to Facebook’s website within 30 days.

ComScore reports that 82% of the world’s 1.2 billion online population participates in some form of social networking. Social networking eats up 20% of the time people spend online. Facebook’s users account for 75 percent of the time spent on social networking websites. Facebook’s users also account for more than 14 percent of the time people spend online around the world.

December 2015 Update: 

Monthly Active Users: 1.59 billion monthly active users as of December 31, 2015

Daily Active Users: 1.04 billion daily active users on average for December 2015

Mobile Monthly Active Users: 1.44 billion mobile monthly active users as of December 31, 2015

Mobile Daily Active Users: 934 million mobile daily active users on average for December 2015

How Does Facebook Make Money?

Facebook does not charge its users a sign-up or monthly fee. So, how does Facebook make money if users like me get to use it for free? There are three sources of revenue for Facebook;

  • Advertising – Facebook can deliver targeted ads to its users based on information that they provide during sign-up or as they interact with their friends.
  • Games + Apps – Facebook is paid a 30 percent fee by companies that develop games and applications for its user base. This fee is applied to in-game or in-app sales.
  • Virtual Goods – Facebook earns a slice of revenue from the sale of virtual goods to its users.

Reports in the press speculated that Facebook’s 2011 revenue would be in the neighborhood of $4.5 Billion. Advertising should account for the majority of that amount, followed by revenue from games and apps. Virtual goods account for only a small portion of Facebook’s revenues.

March 2016 Update: Revenue for the full year 2015 was $17.93 billion, representing an increase of 44% over revenue for the full year 2014.

The Business Model Canvas – The Building Blocks of Facebook’s Business Model

Note: Business Model Generation was not published till July 2010, nearly 6 years after thefacebook.com launched. Still, using the business model canvas to analyze Facebook’s business Model is instructive.

Customer Segments

  • Mass market – any one that uses the internet and wants to connect and socialize with family, friends and other people that are online.
  • Advertisers – big, medium and small companies that wish to advertise to the hundreds of millions of people that spend time on social network websites. Reports estimate that people spend about 3 to 4 times as much time on Facebook as they spend on Google.
  • Developers – apps, social games, and virtual goods.

Value Proposition(s)

  • Enable users to connect and share with family, friends and other people with whom they share a common interest.

Channels

  • Website
  • Mobile App

Customer Relationships

  • Network effects – users will gravitate to the social network where most of their friends are already users.
  • Relatively high switching costs – users are less likely switch to a competitor after sharing a lot of content on Facebook.

Revenue Streams

  • Advertising – fees generated from online display banner ads delivered to users through Facebook.com. There are probably two or three different categories of advertising.
    • Not entirely clear if this will work, but the team has been pitching this to advertisers since it was two months old. Might need to verify this assumption with someone in the advertising industry.
  • Facebook Credits – 30 percent share of in-app and in-game transactions.
  • Virtual goods – straight virtual goods sales not connected to use of an app or a game by the user.

Key Resources

  • People – employees, and Facebook’s more than 800 million active users.
  • Technology – software, servers and other cloud-based services that Facebook must purchase from other companies to support its operations.
  • Brand – people have to trust in what Facebook represents.

Key Activities

  • Developing and improving the Facebook platform – both the frontend user experience and backend data processing capacity. The company was reported to have started working on proprietary server designs to support its operations – reports suggested the company might be worried about the speed at which conventional server designs allow it to serve content to its millions of daily users.

Key Partners

  • Third party developers – apps, games and other features to enable people connect and share with one another using Facebook’s platform.

Cost Structure

  • Employees – Facebook reportedly has between two and three thousand employees spread across offices in 15 countries. The company seems to be preparing for a burst of growth in the size of its workforce.
  • Technology – server maintenance, software latency and optimization issues; this will continue to be a concern as people generate and share more and more content using smartphones.

The company says that more than 50% of its more than 800 million active users log onto Facebook on any given day. Nielsen estimated in a report on social media that American internet users collectively spent more than 53 billion minutes on Facebook in May 2011. The average user has 130 Facebook friends. The company also says people interact with more than 900 million objects on the website and that the average user is connected to 80 community pages, groups and events. On the average day Facebook’s users upload 250 million photos. Facebook is available in 70 languages, and 300,000 users helped to translate the site by using Facebook’s translations app. On the average day, Facebook’s users install apps 20 million times. During the average month, half a billion people use an app on Facebook or experience the Facebook platform on other websites (e.g. to share this story from Tekedia with your friends on Facebook). In all more than 7 million apps and websites are integrated with the Facebook platform. There are 475 mobile operators globally working to promote and deploy Facebook’s mobile products through their mobile networks and on their mobile devices (for example Facebook’s Android, iOS and Blackberry apps). More than 350 million active users currently access Facebook through a mobile device.

Facebook was launched in February 2004. As the preceding paragraph clearly demonstrates, the over-arching elements of Facebook’s business model that we have discussed have led it to unbelievable success. This success has occurred in spite of the fact that Facebook was not the very first social networking company. MySpace launched in August 2003, and before that Friendster was founded in 2002. Classmates.com, SixDegrees.com and Makeoutclub.com preceded Friendster. One may argue that Facebook benefited from technological advancements that its predecessors could not exploit. One may also argue that Facebook launched at a time when millions of people had become accustomed to the concept of social networking. I suspect there’s a lot of truth in both of those arguments. However, I would also argue that Facebook did a better job of understanding the intricacies of its business model better than its predecessors, and then executing that business model more effectively than any of its predecessors. Put those three arguments together and one can see that Facebook’s phenomenal growth is not completely outside the realm of possibility.

Facebook Menlo Park HQ (Image Credit: Facebook)
Facebook Menlo Park HQ (Image Credit: Facebook)

Economic Moats Analysis

I am now going to pretend that I have travelled back in time, to September 2004. As fortune would have it I am a reasonably well-liked early stage VC who invests in startups raising their very first round of capital from institutional investors. Someone I know has introduced me to the founder of The Facebook; and describes it as “a web directory that the college-kids are going crazy about.” I agree to meet in two weeks, when some time opens up on my schedule. In the meantime I start doing some cursory reading about this “thing.”

The issues I am most concerned about are, in order of priority;

First, how do I know that thefacebook.com has proven that its value proposition will hold? Around that time reports in the press highlighted how addictive thefacebook.com had become to its users. Here are some examples:

Even those who don’t know why they love Thefacebook can’t stay away.

“It’s a stupid, stupid website, but I am completely addicted,” freshman Emily Bruckner said. “I just go around and look at all of my friends and see who they’re friends with. It’s like a contest to see who has the most friends.”

Source: Thefacebook.com Opens to Duke Students, Duke Chronicle; April 14, 2004.

Value Proposition – The bottomline: Users love thefacebook.com, and there is plenty room for growth. The are millions of college students around the world that thefacebook could target as users.

Second, do I have a sense of how the team intends to grow the business? Will the team’s ideas about growth work? Based on reports in the press, it appears thefacebook is growing rapidly, and so I have to assume the team has figured what it will take to grow within the market on which it has chosen to focus initially. There may yet be some work to do here, but so far so good. Each user is encouraged to invite some friends upon first signing up for thefacebook, and the website also suggests people that new users might know who are already on the site. Friendster is doing well within the general population, so there’s one example of how thefaceboook too might grow beyond college-campuses . . . when that makes sense.

Growth – The bottomline: The team seems to have figured out a method to accelerate growth on college campuses. That’s a good sign. There may be a few outstanding questions, but this is probably a good point at which to consider making a investment if growth can continue to accelerate.

Third, and finally . . . How does the team believe thefacebook.com will make money? This is a critical question since it speaks to thefacebook.com’s future prospects for becoming a self-sustaining entity. The team has been pitching itself as an online marketing service to advertisers . . . It will be interesting to see how advertisers react to this.

Revenue – The bottomline: Murky. Not clear if this will work. But Google is having success selling ads online through its Content Targeting Advertising. So not out of the realm of possibility. But no definitive answers at hand.

Economic moats help early stage technology startups preserve and enhance the advantages they enjoy over their competitors as time goes on their business model matures. There are five ways in which a startup can build an economic moat; Network Effects, Switching Costs, Efficient Scale or Cost Advantages, Intangibles, and Brand. Note, that I discuss “brand” under the heading of “Intangibles” but it stands alone as one of the 5 sources of an economic moat.

  • Brand: High. Becoming known as the platform for college students for intra- and inter- college social networking. Highly sought after by students at colleges where it is yet to launch a community.
  • Network Effects: High. Platform gets more useful for users as more of their friends sign-on to become users.
  • Efficient Scale or Cost Advantages: High. Users invite friends. Word-of-mouth seems to be spreading and helping keep costs of acquiring new users relatively low.
  • Switching Costs or Buyer Lock-in: Undetermined. Need more data. But should increase as people interact more and more on thefacebook.com. Described as addictive. Wonder how long that addictive quality will last. Need to get better understanding of user-perception of value.
  • Intangibles:
    • Intellectual Property: None necessary right now, but might be needed in the future to solve technical problems caused by growth. TBD.
    • Research and Development: Need to figure out revenue model. Also, what problems has Friendster run into that might be relevant for thefacebook.com? How is the team thinking about this?
    • Culture and Management: TBD. Young team, college students. Mark has prior experience building social-networking applications.

Conclusion: So, would I have invested? I do not know. There is more that goes into a decision like that one than the preceding analysis. However, at first blush there are no “smoking-gun” reasons not to take a closer look. To avoid saying no at this stage it would help to keep the following lessons in mind – they are adapted from Andrew Chen’s discussion about his decision to pass on making an early stage investment in Facebook when he had the opportunity to do so after he convinced himself that “Facebook would never be a billion dollar company.” Note: I wrote about this in April 2012 in a post that was published at Tekedia. The following discussion is adapted from that post.

  • Lack of experience and lack of knowledge are two distinctly different things. Do not confuse them with one another. Pass on making an investment because of a lack of knowledge, do not pass only because of a lack of experience.
  • Do not take solace in data and statistics without first verifying that such analyses are relevant within the given context. Data and statistics often inspire unjustified confidence, but calculations are useless if what you are calculating is wrong, irrelevant or simply inapplicable to the startup’s situation and future markets.
  • Do your own homework. Treat data and statistics from others with extreme skepticism. At the very least, try to interpret third party data based on your own analyses.
  • By definition, your past experience might be useless in understanding the most promising startups that you will encounter. Start from first-principles. Understand the fundamentals of what the startup is trying to do before you leap to conclusions grounded in your past experience. Don’t let your professional history and learned logic become a hindrance.
  • Business models matter, but execution matters more than the relative attractiveness or unattractiveness of the business model that exists at the time you encounter and early stage startup.
  • Heuristics are useful, but only up to a point. See the point on “past experience” above.
  • Keep an open mind, peel away the layers . . . Lack of conformity with the stereotypes you have become familiar with is an insufficient reason for passing on a startup.
  • Lastly, set all the analyses aside and spend some time thinking about what would happen if the team succeeds in accomplishing what it is setting out to do. If that happened, is that a story you’d want to be part of?

 

 

Notes On Strategy; What Can We Learn From Religious Leaders About Building Early-Stage Startup Culture?

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Alternative Working Title: Notes On Strategy; Engineering Your Early Stage Startup’s Culture For Longevity

The topic of culture has been in the news quite a bit since the New York Times published an investigative piece describing what it is like to work for Amazon. While culture is something I think about all the time, that article got me thinking about religion and culture . . . and how that relates to the early stage startups in which we invest.

In this post I plan to:

  1. Examine what we mean when we say “culture” and tie that to the work that startup founding teams do during business model search and discovery.
  2. Examine the structural characteristics of religious communities; How do they maintain a sense of purpose, direction, and elicit devotion and commitment from members of the community?
  3. Provide some pointers about how first-time startup founders might get things off on the right footing as far as culture is concerned by making certain deliberate choices early in the lifecycle of their startup.

I am thinking specifically of startups raising their first institutional round from seed stage venture capitalists, or perhaps a Series A round of financing. These teams are usually small, often fewer than 10 people.

To get things started; What is Culture?

Culture is the learned and shared behavior of a community of people which distinguishes that community from other communities. 1J. Useem and R. Useem. (1963). Human Organizations, 22(3). Page 169. See: The Center for Advanced Research on Language Acquisition (CARLA) “What is Culture?” http://www.carla.umn.edu/culture/definitions.html. Accessed Aug 29, 2015.

Some of the things that distinguish a culture: 2Adapted from: Richard-Hooker.com; Clifford Geertz, Emphasizing Interpretation

  1. It embodies a way of life, an approach to thinking, feeling, and believing about the world.
  2. It endows the members of the cultural community with a social legacy from prior members of the same community.
  3. It provides a framework that enables members of the community to think abstractly about how they should behave;
    1. It provides lessons about how members of the community should react towards recurring problems by pooling the collective wisdom of past and present members of the community.
    2. It provides a guide for community members when they need to interact with the external environment.
  4. It is the process by which the history of the community is created and brought into permanent existence.

In this analysis I am most interested in religion as a cultural system.

According to Clifford Geertz religion is: 3Clifford Geertz, Religion As A Cultural System. In: The Interpretation of Cultures: Selected Essays. Pp. 87 – 125. Fontana Press, 1993.

  1. A system of symbols which acts to
  2. Establish powerful, pervasive, and long-lasting moods and motivations in people by
  3. Formulating conceptions of a general order of existence and
  4. Clothing these moods and motivations with such an aura of factuality that
  5. The moods and motivations seem uniquely realistic.

It is not difficult to see that a religion is in fact a specific type of culture and further, that every cultures is a kind of religion. In the rest of this post I will use the term “religion” and “culture” interchangeably. I also assume that a symbol may be tangible or intangible.

The structural characteristics of a religion are: 4William E. Paden, Religious Worlds: The Comparative Study of Religion. 2nd edition. Pp. 51 – 161. Beacon Press, 1994.

  1. A religion inhabits a unique world: Religions create, structure and propose a universe that is unique to adherents of that religion such that members of the community can explain, make sense of, and differentiate what is within their world from what is outside their world. This helps establish lines of commonality as well as lines of difference, and helps confront change and challenges.
  2. A religion is grounded on certain myths: Every religion possesses sacred myths that tell a story about something that happened during the genesis of the religion and that continues to have great influence on contemporary realities experienced by adherents of the religion. Myths:
    1. Help devotees of a religion make sense of the past, the present, and the future.
    2. Are a powerful means of engendering a certain mood and attitude within the devotees of a religion.
    3. Focus our attention on that which is sacred and important within a religion.
  3. A religion possesses rituals: Rituals help to focus the devotees of a religion on specific concepts or ideas at a specific point in time, also rituals enable the adherents of a religion to express their beliefs about the world in the form of a tangible display that appeals to the senses through action.
  4. A religion possesses gods: In the context of religious worlds, gods represent instances of language and behavior that is held up by the religious community as exemplary, worthy of emulation, and possessing interpretive power in terms of how that community understands the world.
  5. A religion possesses systems of purity: These systems of purity help to differentiate what is acceptable from what is unacceptable, right behavior from wrong behavior. This is a system that enables members of the community deal with negativity within the community.

What role do symbols play within a culture?

  1. Anat Rafaeli and Monica Worline: Symbols in Organizational Culture – A symbol is a visible and physical manifestation of an organization. It is an indication of organizational life that derives its meaning from the social and cultural conventions and interactions among the people who belong to the cultural organization. Symbols can be experienced through the senses. Symbols play the following functions:
    1. They reflect organizational culture: Symbols communicate information about what we think we know about an organization. They act as a bridge between our emotional and cognitive responses towards an organization.
    2. They trigger internalized values and norms: Symbols serve as a cue to trigger certain expected, desired, and acceptable behaviors once a person enters the physical environment of an organization or whenever the person is acting explicitly as a representative of the organization to the outside world.
    3. They frame conversations about experience: Symbols act as a frame of reference for guiding the communication that takes place between members of the same organization, or between members of a specific organization with people who do not belong to that organization.
    4. They integrate organizational systems of meaning: Symbols integrate the culture, norms and values, and shared experiences of members of an organization into a coherent whole within which members of the organization experience the world.
  2. Sherry Ortner: On Key Symbols – A key symbol is an element of a culture that is crucial and distinctly unique to the organization of that culture. They perform the function of carrying and conveying cultural meaning to people within the culture as well as to people outside the cultural community. Key symbols might be identified when:
    1. Members of the cultural group discuss the symbol’s cultural significance,
    2. Members of the cultural group are positively or negatively aroused by the symbol, and none are indifferent towards it,
    3. The symbol appears in many different settings and contexts,
    4. There is much elaboration around the symbol, and
    5. The group imposes numerous restrictions around the symbol. For example, misuse of the symbol can incur severe sanctions.

There are two distinct categories of key symbols. Summarizing symbols express meaning in an emotionally powerful way that is of uniform significance for all members of a given culture. They are generally accorded sacred status. Elaborating symbols make it possible for members of the religion or community to communicate ideas and feelings with one another, and to translate such feelings and ideas into tangible action. Elaborating symbols are generally analytic in nature and rarely attain sacred status.

What does this mean in the context of building an early-stage startup?

  1. Communicate a clear world view internally and externally. One question I ask myself when I meet with a founder is this; Why is this specific person uniquely suited to solve this problem in this market and why do I believe this team will succeed in its effort to accomplish this incredibly difficult task?
  2. Preserve and embellish important stories, particularly those that reflect qualities and themes that the founder wants to become aspects of the startup’s long-term culture and identity. I listen for founders who express enthusiasm for the work that the other people on the team are doing. Team cohesiveness matters.
  3. Create and maintain rituals:  For example, does every team member understand what would get existing customers/users to become more engaged with the product, and reduce churn? Does every team member know what needs to happen for the startup to increase its growth enough to get to the next funding milestone? Does the founder have a firm grasp on the startups key performance indicators? Has the team chosen the right indicators to focus on at this stage?
  4. Focus on finding product/market fit: A startup that fails to find product/market fit is doomed. Are the founders experimenting enough to find an ideal early market for the product, or are they stuck in a cycle of dogma regarding an initial point of market entry? What indications are there to help me ascertain the quality of their decision-making processes?
  5. Create systems of accountability: At the very early stage of a startup’s life the individuals on the team have an enormous impact on the organizational culture that eventually evolves. What steps are the founders taking to ensure that the early team has the right mix of people?
  6. Create a sales and marketing plan: What steps is the startup taking to create strong bonds with its earliest customers/users? Is anything being done to create a brand? Are the choices that have been made so far cost-effective and appropriate for the startup’s stage of maturity and its funding status?

Closing Thoughts The job of an early-stage technology startup founder is basically akin to that of a religious evangelist. The founder must recruit believers. Early team members join the cause because they believe in the founder and in the vision that the founder wishes to bring into reality. Early customers become believers because they have a problem they believe the startup’s envisioned product can solve. Early investors join the cause because they believe in the founder and believe that the startup can create the future reality that it describes during investment pitches. Basically, at the outset . . . Building a startup is exactly the same as creating a new religion.

 

References

J. Useem and R. Useem. (1963). Human Organizations, 22(3). Page 169. See: The Center for Advanced Research on Language Acquisition (CARLA) “What is Culture?” http://www.carla.umn.edu/culture/definitions.html. Accessed Aug 29, 2015.
Adapted from: Richard-Hooker.com; Clifford Geertz, Emphasizing Interpretation
Clifford Geertz, Religion As A Cultural System. In: The Interpretation of Cultures: Selected Essays. Pp. 87 – 125. Fontana Press, 1993.
William E. Paden, Religious Worlds: The Comparative Study of Religion. 2nd edition. Pp. 51 – 161. Beacon Press, 1994.

Notes on Strategy; Where Does Disruption Come From?

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Introduction

You can imagine my surprise when I was browsing my Twitter feed one night last month and came across one of Marc Andreessen’s tweetstorms. This time he was tweeting about Clayton Christensen’s Theory of Disruptive Innovation.

Coincidentally, I have been thinking about writing a blog post on the subject since the Fall of 2014 – after a string of successive meetings with startup founders in which it became starkly clear to me that they were using the term “disruption” without actually understanding what it meant, or perhaps I should say, they used the term in a context that differs markedly from my understanding of what it means.

The purpose of this blog post is to; 1Any errors in appropriately citing my sources are entirely mine. Let me know what you object to, and how I might fix the problem. Any data in this post is only as reliable as the sources from which I obtained them.

  1. Synthesize my understanding of Disruptive Innovation as popularized by Clayton Christensen’s work,
  2. To examine instances in which that process has unfolded in various industries,
  3. To develop a framework by which I can analyze a startup founders’ claims about “being disruptive” during my conversations with them, and
  4. Examine extensions of, and arguments against, Clayton Christensen’s work on Disruptive Innovation

I am thinking of this from the perspective of an early stage Seed and Series A investor in technology startups, not from the perspective of a management consultant advising market incumbents about how to avoid or prevent competition.

To insure that we are on the same page; first some definitions.

Definition #1: What is a startup? A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model. 2I am paraphrasing Steve Blank and Bob Dorf, and the definition they provide in their book The Startup Owner’s Manual: The Step-by-Step Guide for Building a Great Company. I have modified their definition with an element from a discussion in which Paul Graham, founder of Y Combinator, discusses the startups that Y Combinator supports.

Definition #2: What is Sustaining Innovation? A “sustaining innovation” is an innovation that leads to product improvements without fundamentally changing the nature or underlying structure of the market to which it applies; it enables the same set of market competitors to serve the same customer base. 3Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition.

In other words; a sustaining innovation solves a problem that is well understood within an existing market. The innovation improves performance, lowers costs and leads to incremental product improvements. The customers are easily identified, and market reaction to the innovation is predictable. Lastly, traditional business methods known within that market are sufficient to bring the innovation to market. 4Brant Cooper and Patrick Vlaskovits, The Lean Entrepreneur. Wiley, 2013, pp. xx.

Additionally;

  1. A sustaining innovation is evolutionary if it leads to product improvements that are gradual in nature, progressing along what might be described as a gradual step function.
  2. A sustaining innovation is revolutionary, discontinuous, or radical when it leads to product improvements that are dramatic and unexpected in nature, but that nonetheless leaves the market structure largely intact – even if there is a rearrangement of counterparties within the existing competitive hierarchy.
  3. Even the most dramatic and difficult sustaining innovations rarely lead to the failure of leading incumbents within a market. 5Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition, pp. xviii.

Definition #3: What is Disruptive Innovation? A “disruptive innovation” is one that starts out being worse in product performance in comparison to the alternative, in the immediate term. However, as time progresses the disruptive innovation leads to a significant and fundamental shift in market structure – new entrant competitors serve an entirely changed customer base. 6Ibid.

In other words; a disruptive innovation solves a problem that is not well understood by the market, thus creating a “new market” for the new entrant. The innovation is dramatic and game-changing in ways that initially elude the mainstream customers as well as market incumbents serving those customers. The customer is often difficult to identify at the outset, and market reaction toward the innovation is unpredictable – from the perspective of the mainstream. Traditional methods and business models that have served the market can not support the innovation. 7Brant Cooper and Patrick Vlaskovits, The Lean Entrepreneur. Wiley, 2013, pp. xx.

Additionally;

  1. A disruptive innovation introduces a different and “comparatively inferior” value proposition than the value proposition the existing market is accustomed to; as such
  2. Disruptive innovations start out being attractive only to a relatively “fringe” and “new” but altogether “unprofitable” customer base with products that are;
  3. “Cheaper, simpler, smaller, and more convenient” for the customers that find them most attractive at the outset, and
  4. These products perform so “poorly” that mainstream customers in that market will not use them, and incumbent players are happy to keep “their best, and most profitable customers” while ceding “their worst, and unprofitable customers” to the startup bringing the disruptive innovation to market, but
  5. Eventually the disruptive innovation leads to market shifts which cause leading incumbents to fail as the new entrants supplant them.
Image Credit: Vadim Sherbakov
Image Credit: Vadim Sherbakov

Understanding What is Happening When a Market Undergoes Disruption

So what exactly is going on when a market experiences disruption? Contrary to what the term “disruptive innovation” suggests . . . the process is not sudden.

As Clayton Christensen states; Disruptive innovations are generally straightforward technologically. They consist of off-the-shelf components combined in a product architecture that is far simpler than existing alternatives or substitutes in a way that does not meet the needs of the core customers in an established market. They will often be derided and dismissed by incumbents as “inferior” because they offer benefits prized by an emerging class of customers in an emerging, but as yet unnoticed market. The disruptive innovation starts out being unimportant to the mainstream customer and so it is unimportant to the mainstream incumbent. 8Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition, pp. 16.

Mainstream customers and mainstream investors hold mainstream incumbents captive – with demands for sustaining innovations, and demands for meeting or beating financial performance metrics like internal rate of return, net present value, return on equity, return on invested capital, gross margins, net margins etc. Faced with the choice between pursuing an unprofitable emerging class of customers or doubling down in the competition for the most profitable mainstream customers in that market, management teams running mainstream incumbents do the rational thing; they double down in heated competition for profitable customers.

The disruptive innovation improves so rapidly, that it soon starts to meet the needs of segments of the mainstream customer base. As the cycle continues, it reaches a stage where the incumbents find themselves squeezed into a tiny corner of the market, driven out of it altogether, or dead.

This process describes a “low-end disruption.”

Disruptive innovation might take another form; in a “new market disruption” the startup initially sets its sights on customer segments that are not being served by mainstream incumbents within a given market. A new market disruption starts by competing “outside” of an existing market; in new use-cases, or by bringing in customers who previously did not consume because of they lacked the know-how or financial resources needed to use the incumbent product. The new market is “small and ill-defined” . . . However, as the new entrant grows and improves its product, customers begin to abandon the incumbent in favor of the disruptive innovation. Usually, the incumbent cannot compete with the new entrant because the new-market disruption is accompanied by a structurally distinct business model which makes it feasible for the new entrant but infeasible for the incumbent, for example a cost structure that is so thin that it could not support the incumbent’s fixed costs. 9Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution. 2003, Harvard Business School Publishing, pp. 45.

What Is The Innovator’s Solution; For Early Stage Startups and Early Stage Venture Capitalists?

Of the many dimensions of business building, the challenge of creating products that large numbers of customers will buy at profitable prices screams out for accurately predictive theory.

– Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution

First: Understand Why Customers Buy What causes customers to buy a product? A startup wishing to disrupt an established market needs to be able to answer this question in a way that existing incumbents have not. The “Jobs-To-Be-Done” (JTBD) framework enables a startup to develop its product at the “circumstance” in which its customers find themselves at the time they need its product, and not directly at the circumstances. As Christensen and Raynor put it: “The critical unit of analysis is the circumstance and not the customer.”

The basic idea behind the jobs-to-be-done framework is that customers “hire” a product when they need to get a specific “job” done. The entrepreneur who understands what job the startup’s product is being hired to do can also develop an understanding of the other jobs that might be related and ancillary to the primary job. The regularity and frequency with which customers need to get that job done plays a role in product development; what features should be prioritized? Which features should be de-prioritized even though they at first seemed important? How should the product’s value proposition be communicated? What other features should be built so that customers need not combine several different products in order to complete the job, or if they do how does the startup capture those markets too?  10Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution. 2003, Harvard Business School Publishing, chapter 3.

In my opinion startups stand an even better chance of success if they can combine the JTBD framework with an understanding what broad needs their product satisfies for their customers using the parameters laid out by Maslow’s Hierarchy of Needs. This matters especially in the determination of how a startup should communicate the product’s value proposition to its target customer base. An incongruence between the startups marketing message and the customers’ psychological notions about the product will lead to missed opportunities for the startup. It might also lead a startup to chase after the wrong customer base at the outset. 11Startups building products for the enterprise customer should be able to develop an analogous framework, assuming one does not already exist.

When new ventures are expected to generate profit relatively quickly, management is forced to test as quickly as possible the assumption that customers will be happy to pay a profitable price for the product.

– Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution

Second: Be Patient For Growth But Impatient For Profits The investors and founders of a startup that claims to be disrupting a market must quickly test if the market dynamics the startup must confront are such that it can earn a profit given its business model. This is important because it indicates that for those startups that answer those questions positively, it is possible for them to pursue growth in a way that is healthy and sustainable irrespective of the magnitude of the growth.

The Startup Genome Report reached conclusions that support this notion. In an extra to the 2011 version of that report they study the effect of premature scaling on the longevity of startups. They found that 70% of the 3200+ high-growth technology startups scaled prematurely along some business model dimension.

Before delving deeper into the findings from the Startup Genome Report, we should understand “Product-Market Fit“. An early stage startup is approaching the product-market fit milestone when demand for its product at a price that is profitable for the startup’s business model, begins to outstrip the demand that could have been explained by its marketing, sales, advertising, and PR efforts.

Product/market fit means being in a good market with a product that can satisfy that market.

You can always feel when product/market fit isn’t happening.The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of “blah”, the sales cycle takes too long, and lots of deals never close.

And you can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can. Reporters are calling because they’ve heard about your hot new thing and they want to talk to you about it. You start getting entrepreneur of the year awards from Harvard Business School. Investment bankers are staking out your house. You could eat free for a year at Buck’s.

– Marc Andreesen 12Marc Anrdeesen, Product/Market Fit, Jun 25, 2007. Accessed on Jul 18, 2015 at http://web.stanford.edu/class/ee204/ProductMarketFit.html

In other words, the product-market fit milestone is that milestone at which we start to realize that the startup has an opportunity to grow in sustainable and profitable way. As organic demand for the product starts to overwhelm the startup – i.e. as the market starts to pull the product out of the startup, that is the point at which it makes sense for investors to become impatient for growth. Before Product-Market Fit (BPMF) a startup must “push” its product onto the market – customers and revenue grow in direct, linear proportion to sales and marketing expense. After Product-Market Fit (APMF) the market “pulls” the product out of the startup – customers and revenue grow positively, disproportionately, and exponentially out of proportion to any sales and marketing expense incurred by the startup. Investors and startup founders should become impatient for growth when the startup is in the APMF phase of its life-cycle. This approach should hopefully avoid situations like: Case Study: Fab – How Did That Happen?

According to Startup Genome Report Extra on Premature Scaling:

Note: They use the term “inconsistent startups” to describe startups that scale prematurely and “consistent startups” to describe startups that scale successfully.

  1. 74% of startups scale prematurely.
  2. Startups that scale appropriately grow about 20x faster than startups that do not.
  3. Inconsistent startups that raise funding from investors tend to be valued 2x as much as consistent startups and raise about 3x as much capital prior to failing.
  4. Inconsistent startups have teams that are 3x the size of the teams at consistent startups at the same stage.
  5. However, once they get to the scaling stage, consistent startups have teams that are 1.38x the size teams at inconsistent startups.
  6. Consistent startups take 1.76x as much time to reach the scale-stage team size than their inconsistent peers.
  7. Inconsistent startups are 2.3x more likely to spend more than one standard deviation more than the average cost to acquire a customer than their consistent peers.
  8. Inconsistent startups write 3.4x more lines of code and 2.25x more lines of code in the discovery and efficiency stages of their life-cycle. Discovery and efficiency are the first and third stages of the startup lifecycle, as described in the report. 13In their report they describe the stages of a startup’s life-cycle as Discovery, Validation, Efficiency, Scale, Sustenance, and Conversation. The report covers the first four.
  9. A majority of inconsistent startups are more likely to be efficiently executing irrelevant things at the Discovery, Validation, and Efficiency stages of their life cycle, while a majority of consistent startups seek product-market fit during those stages.
  10. The following attributes have no correlation to the likelihood that a startup will be inconsistent or consistent: market size, product release cycles, educational attainment, gender, age, length of time over which co-founders have known one another, location, tools used to track KPIs etc.

What are some of the mistakes that inconsistent startups make as they travel from launch to dysfunctional scaling to failure? The Startup Genome Report provides some examples:

Customer

  1. Spend too much on customer acquisition BPMF and before discovering a profitable, repeatable and scalable business model, and
  2. Attempt to ameliorate that problem with marketing, press, and public appearances.

Product

  1. Build a “perfect product” before knowing enough about the “Problem-Solution Fit”, and
  2. Investing into scaling the product BPMF, and
  3. Focusing on advanced product features which are later proven to be unimportant to customers.

Team

  1. Growing the team too fast,
  2. Hiring specialists and managers too early and not having enough people who can or will actually do the work that needs to get done, and
  3. Having too much hierarchy too early.

Finance

  1. Raising too little money at the outset,
  2. Raising too much money. 14This is a risk for early stage investors as well as startups.

Business Model

  1. Not spending enough time developing the business model, and only realizing after the fact that revenues will never support the startup’s cost structure.
  2. Focussing too much on maximizing profit too early in the startup’s life-cycle,
  3. Executing without observing and analysing the input from customers and the market, and
  4. Failing to pivot appropriately in the face of changing market conditions that are relevant to the startups based on its discovery-focused experiments.

The 4 Stages Of Disruption

In his article, Four Stages of Disruption, Steven Sinofsky describes the process of disruption using an analogy to the well known and well understood rubric for understanding the experience of someone experiencing significant loss.

The 4 stages of disruption are:

  1. Disruption: A new product appears on the market but is seen to be inferior to the existing mainstream alternative.
  2. Evolution: The new product undergoes rapid sustaining innovations.
  3. Convergence: The new product is now seen as a plausible replacement for the incumbent mainstream product because it has undergone enough sustaining innovations to make it comparable to the incumbent.
  4. Reimagination: During this stage there is a complete re-examination of the assumptions on which the market operates and new products are brought to market.

Sinofsky describes them as a process, as shown in the following diagram:

The 4 Stages of Disruption (Credit: Steven Sinofsky)
The 4 Stages of Disruption – Process (Credit: Adapted from Steven Sinofsky)

 

I think the framework is better understood as a cycle; because every incumbent must face a new entrant or new entrants seeking to disrupt the market and eventually every successful new entrant that disrupts a market itself becomes an incumbent facing disruption by a successive hoard of disruptive new entrants. The cycle is ongoing and continuous, and is driven by more than simple advances in technology. Human behavior plays a central role in shaping the cycle that creates room for disruption to occur because our tastes change over time, and as time progresses we begin to value things that we did not value in the past, and it is that insight into the confluence between technology and human behavior that enables certain entrepreneurs to build startups that become industry disruptors.

 

4 Stages of Disruption - Cycle
The 4 Stages of Disruption – Cycle (Credit: Adapted from Steven Sinofsky)

 

How Did That Happen? – Disruption in Action; Industries

Digital Cameras vs. Film Photography: Digital cameras threatened to disrupt film photography, but they mainly represented a sustaining innovation – largely improving on existing form factors already in use in that market and fulfilling the needs of people one would consider casual or professional photographers. It was not until digital camera technology was integrated into smart-phones that the photography market started to experience disruption. They appealed to anyone who had the desire to take a picture, photographer or not, it did  not matter. As Craig Mod argues in his 2013 New Yorker article Goodbye, Cameras: “In the same way that the transition from film to digital is now taken for granted, the shift from cameras to networked devices with lenses should be obvious.” Standalone cameras are simply no longer good enough because: “They no longer capture the whole picture.” Kodak’s demise follows the classic format of every great incumbent that has fallen into obscurity in the face of an onslaught from new entrants. Kodak was itself a disruptor at one point – taking photography out of the sole preserve of professionals and putting it in the hands of every casual photographer seeking to preserve memorable moments. In his 2012 Wall Street Journal article, Kamal Munir outlines the rise and fall of Kodak in The Demise of Kodak: Five Reasons. It is important to note that Kodak developed technology for a digital camera in 1975, yet it failed to understand why customers bought its products and so failed to shift its business model as aggressively as it could have to avoid the fate that began staring it it in the face in 1975, nearly 4 decades before it filed for bankruptcy. 15Theodore Levitt’s seminal HBR article “Marketing Myopia” first introduced this concept in 1960. You should read the original article as well as this update from 2004.

Mobile Phones vs. Fixed Line Telephones: One sign that mobile and broadband telephony is disrupting fixed line telephony is the European Commission’s 2014 decision to stop regulating fixed line telephony. The situation for fixed line telephony is no different with telephone companies announcing that they are abandoning their landline telephone infrastructure in favor of mobile and broadband phone service. Their reaction is being driven by consumer’s willingness to rid themselves of landlines in favor of cellphones for individual personal use and/or VOIP-enabled phones at home. Liquid Crystals were first discovered by the Austrian physicist Friedrich Reinitzer in 1888. Nearly 7 decades later, engineers and scientists at RCA were conducting research that led them to file the first LCD patent on November 9, 1962. The USPTO granted them the patent on May 30, 1967. However, RCA did not move aggressively enough to make the LCD technology that had been developed by its employees the center of its business model.

Liquid Crystal Displays vs. Cathode Ray Tubes: The emergence of LCD technology marked the beginning of the end for CRT technology in the TV market. The technology that led to the development of LCD televisions originated in 1888, when an Austrian Physicist, Friedrich Reinitzer discovered the strange behavior of cholesteryl-benzoate. Nearly 4 decades later, scientists and engineers working at RCA filed a patent application based on LCD technology on Nov 9, 1962. It was granted on May 30, 1967. Predictably, RCA did not do much with its head-start in the development of LCD technology, instead it gave up its advantage to Japanese, Korean, and Taiwanese upstarts.

 

Statistic: Global market share held by LCD TV manufacturers from 2008 to 2014 | Statista
Find more statistics at Statista

 

How Did That Happen? – Disruption in Action; Companies/Products

Google – Launching Sustaining and Disruptive Innovations:

 

While Google’s innovation in search are impressive, and helped it win that market at the expense of other search engines, it gained near absolute dominance in that market by developing a sustaining innovation in the form of its PageRank Algorithm, which is described in the paper by Sergey Brin and Lawrence Page: The Anatomy Of A Large Hypertextual Web Search Engine.
Statistic: Worldwide market share of leading search engines from January 2010 to April 2015 | Statista
Find more statistics at Statista

 

Rather, the industry that has been disrupted by Google is the online advertising market. Describing this in his article “What Disrupt Really Means” Andy Rachleff writes: “It was AdWords, its advertising service. In contrast with Yahoo, which required advertisers to spend at least $5,000 to create a compelling banner ad and $10,000 for a minimum ad purchase, Google offered a self-service ad product for as little as $1. The initial AdWords customers were startups that couldn’t afford to advertise on Yahoo. A five-word text ad offered inferior fidelity compared with a display ad, but Google enabled a whole new audience to advertise online. A classic new-market disruption. Most have forgotten that Google added significant capability to its advertising service over time and then used its much-lower-cost business model (enabled by self-service) to pursue classic Internet advertisers. Thus it evolved into a low-end disruption.”     Statistic: Net digital ad revenues of Google as percentage of total digital advertising revenues worldwide from 2012 to 2014 | Statista Find more statistics at Statista   Salesforce – Launching New Market and Low-End Disruptions: When Salesforce launched in 1999 it did so as a software-as-a-service (SaaS) platform that enabled companies that needed sales management software but could not afford the cost of annual multimilion dollar licenses for the mainstream products of the day. It’s initial product was lacking in features, and unreliable for the mainstream customers of the incumbent players in the CRM software market at that time. It built its business on non-consumption. As time progressed and its product matured in terms of reliability and features, Salesforce caused a low-end disruption as customers adopted its product while abandoning the more expensive CRM products sold by CRM market incumbents like Siebel Systems, Amdocs, E.piphany, PeopleSoft, and SAP.     Statistic: Market share of vendors customer relationship management software worldwide from 2012 to 2014 | Statista Find more statistics at Statista   Apple: Has Apple launched any disruptive innovations? Not if you asked Clayton Christensen in 2006 or again in 2007, or even in 2012. Yet I suspect that Nokia and Research in Motion feel differently about that question. The chart below is instructive.     IDC: Smartphone Vendor Market Share 2015, 2014, 2013, and 2012 Chart   Apple’s products have not been disruptive in the way that one might think of disruption if one adheres strictly to the line of analysis followed by Clayton Christensen and his collaborators. Perhaps one can argue that the iPod, the iPhone, and the iPad, each taken individually represents a sustaining innovation in the personal music player, the mobile phone, and the personal computer markets respectively. However, when one combines each of those products with the other elements in Apple’s product lineup there’s no denying that Apple has been disruptive to more than one industry. The “iPod + iTunes” has reshaped how people consume music, and has upended the music industry. The iPhone has led to a rethinking of what people expect from a mobile phone, and “iPod + iTunes + iPhone + AppStore” is responsible for the demise of Nokia and Research in Motion’s Blackberry as it has redefined how people consume media of all types. The “iPad + AppStore” combination is redefining how people consume media of all types, and redefining the relationship people have with their personal and laptop computers. Apple demonstrates the power of technology + design + branding + marketing as a powerful force in the process of disrupting established industries in consumer markets. 16It is worth noting that Clayton Christensen’s analysis and research focuses on business-to-business markets.     Statistic: 4G mobile device shipments worldwide from 2009 to 2020 (in 1,000 units) | Statista Find more statistics at Statista   Infographic: Has the PC Industry Bottomed Out? | Statista You will find more statistics at Statista   Netflix: At the outset Netflix seemed like a joke to executives at Blockbuster which dominated the US market for home-movie and video-game rental services, reaching its peak with 60,000 employees and 9,000 physical stores in 2004 after its launch on october 19, 1985. Netflix was founded in 1997 and started out as a flat-rate DVD-by-mail service in the United States using the United States Postal Service as its distribution channel. Presumably, the idea for Netflix was born after Reed Hastings, one of its co-founders was hit with a $40 late-fee after returning a DVD to Blockbuster well after its due date.  

Netflix DVD Mailer (Image Credit: Netflix)
Netflix DVD Mailer (Image Credit: Netflix)
Automated Netflix Mailer Stuffer (Image Credit: Netflix)
Automated Netflix Mailer Stuffer (Image Credit: Netflix)
Order Processing & Shipping Center (Image Credit: Netflix)
Order Processing & Shipping Center (Image Credit: Netflix)
Order Processing & Shipping Center: Sleeve Labels (Image Credit: Netflix)
Order Processing & Shipping Center: Sleeve Labels (Image Credit: Netflix)

  As you might imagine, executives at Blockbuster did not see the threat posed by Netflix and passed on 3 opportunities to buy Netflix for $50 Million. They failed to understand that people would rather not pay exorbitant late fees and that people valued the convenience of dropping the DVD from Netflix in the mail more than they enjoyed driving to Blockbuster’s physical retail stores. In other words; Netflix fulfilled the JTBD of “entertain me at home with something better than my options on TV” more conveniently than Blockbuster. The challenge that netflix must now face is how that original JTBD that it was hired to do by consumers is changing given the proliferation of mobile devices and the shift in consumer preferences away from physical media towards streaming media.      Infographic: Netflix' Successful Transition | Statista You will find more statistics at Statista

 

 But management and vision are two separate things. We had the option to buy Netflix for $50 million and we didn’t do it. They were losing money. They came around a few times.  – Former High-ranking Blockbuster Executive 17Marc Graser, Epic Fail: How Blockbuster Could Have Owned Netflix. Nov 12, 2013, accessed on Jul 18, 2015 at http://variety.com/2013/biz/news/epic-fail-how-blockbuster-could-have-owned-netflix-1200823443/

 

 

To anyone that ever rented a movie from BLOCKBUSTER, thank you for your patronage & allowing us to help you make it a BLOCKBUSTER night. — Blockbuster (@blockbuster) November 10, 2013

Blockbuster filed for bankruptcy in 2013. Today Netflix is streamed online through many internet-enabled smart tvs, streaming media players, game consoles, set-top boxes, blu-ray players, smartphones and tablets, as well as personal and laptop computers.

What Common Traits Do the Startup Founders Who Lead Disruptive Startups Share?

Disruptive innovation is built on much more than technology innovation. The startups that go on to disrupt markets combine innovation in technology with innovative approaches to market segmentation, product positioning, marketing strategy, business model innovation, business strategy, corporate strategy, customer psychology, and organizational design and culture.

As an investor in early stage technology startups that are still in the searching for and trying to validate a repeatable, profitable, and scalable business model it is critical that I become good at recognizing startup founders who can successfully see disruption through to a profitable harvest for the founders, and the LPs to whom I am responsible.

According to The Innovator’s DNA, startup founders capable of leading disruptive new market entrants display the following traits:

  1. Association: They make connections between seemingly disparate areas of knowledge, leading them to novel conclusions that elude other people.
  2. Questioning: They exhibit a passion for questioning the status quo.
  3. Observing: They learn by watching the world around them more closely than their peers and competitors.
  4. Networking: They have a social network that is wide and diverse, which enables them to test their own ideas as well as seek ideas from people who may see the world from a  distinctly different point of view.
  5. Experimenting: They continuously test their assumptions and hypotheses by unceasingly exploring the world intellectually and experientially.

These skills are echoed in The Creator’s Code, which describes extraordinary entrepreneurs as people who:

  1. Find The Gap: by staying alert enough to spot opportunities that elude other people by transplanting ideas across divides, merging disparate concepts, or designing new ways forward.
  2.  Drive For Daylight: by staying focused on the future, and making choices today on the basis of where they see the market going instead of where the market has been.
  3. Fly The OODA Loop: by continuously and rapidly updating their assumptions and hypotheses through the Observe, Orient, Decide, and Act framework. Fast cycle iteration helps them gain an edge over their competition, and catchup with the mainstream market incumbents. 18See statements like: “Move fast and break things.” or “Let chaos reign.”
  4. Fail Wisely: by preferring a series of small failures over a few catastrophic setbacks by placing small bets to test new ideas in order to gain further insight before they place big bets. By doing this they create organizations that learn how to turn failure into success and develop an inbuilt structural resilience.
  5. Network Minds: by harvesting the knowledge and brainpower from cognitively and experientially diverse individuals they develop unique approaches to solving multifaceted problems, problems whose solution might elude competitors.
  6. Gift Small Goods: by behaving generously towards others they strengthen relationships and build goodwill towards themselves and the organizations that they lead.

In The Questions Every Entrepreneur Must Answer, Amar Bhidé outlines a number of questions the feels every entrepreneur must answer in order to determine fit of the entrepreneur to the startup venture and of the startup venture to its context. 19Amar Bhidé,The Questions Every Entrepreneur Must Answer. From The Entrepreneurial Venture, readings selected by William A. Sahlman et al. 2nd edition, pp. 65 – 79. The questions are as follows;

  1. Where does the entrepreneur want to go?
    1. What kind of enterprise does the entrepreneur need to build in order to get there?
    2. What risks and sacrifices does such an enterprise demand?
    3. Can the entrepreneur accept those risks and sacrifices?
  2. How will the entrepreneur and the startup get there?
    1. Is there a strategy that can get the startup there?
    2. Can that strategy generate sufficient profits and growth within a time-frame that make sense for the entrepreneur and for the startup’s investors?
    3. Is the strategy, and the startup’s business model defensible and sustainable? 20I have discussed economic moats here: Revisiting What I Know About Network Effects & Startups and here: Revisiting What I Know About Switching Costs & Startups
    4. Are the goals for growth too conservative, or too aggressive?
  3. Can the founder or co-founders do it?
    1. Do they have the right resources and relationships?
    2. How strong is the relationship between the co-founders with one another, how strong is the organization’s team cohesion?
    3. Can the founder play her role?

The Role of Experts in Predicting The Success or Failure of Disruptive Innovations

Early stage investors often rely on the advice of subject matter experts as part of the due diligence process. Experts are great for determining if the technical innovation works as the founders say it does, however where investors can go wildly wrong is when they rely on subject matter experts for investment recommendations for disruptive innovations.

It should be obvious by now that most experts are poorly placed to offer advice that will be seen as correct when examined in hindsight if they are faced with a disruptive innovation.

The Only things we really hate are unfamiliar things.

– Samuel Butler, Life and Habit

The difficulty subject matter experts face in predicting how markets will evolve is captured in The Lexicon of Musical Invective, where the author captures the vituperous reactions of music critics to works that are now widely considered as masterpieces in the pantheon of Western music history. Why did these experts fail? They did not allow for the possibility that the future might differ from the present in which they were performing their analysis, nor did they allow for the possibility that people’s tastes in music would evolve away from what they had grown accustomed.

Experts experience too much cognitive dissonance when they have to make an investment recommendation regarding a disruptive innovation; what does it mean for their personal career security, what does that mean for the skills that they have worked so hard and so long to accumulate, what does that mean for their employer’s business?

Moreover, the fact that an individual is an expert in the technology behind the disruptive innovation does not mean that the same individual is an expert in all the other disciplines that are required to turn the technological innovation into a disruptive innovation.

Here are a few examples of instances in which experts got things horribly wrong: 21Adapted from Top 10 Bad Tech Predictions, by Gordon Globe. Nov 4, 2012, accessed on Jul 19, 2015 at http://www.digitaltrends.com/features/top-10-bad-tech-predictions/5/

  1. In 1977 Ken Olson said: “There is no reason anyone would want a computer in their home.” He was an engineer by training, and president, chairman and founder of Digital Equipment Corporation. Microsoft and Apple were startups.
  2. In 1956 Herbert Simon said: “Machines will be capable, within twenty years, of doing any work a man can do.” He made this statement after attending an AI conference at Dartmouth.
  3. In 1946 Darryl Zanuck said: “Television won’t be able to hold on to any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.” He was a Hollywood magnate.
  4. In 1995 Robert Metcalfe said: “I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.” He co-invented Ethernet technology and co-founded 3Com in 1979 with 3 other people. 3Com develops computer network products.
  5. In 1995 Clifford Stoll said: “The truth is no online database will replace your daily newspaper, no CD-ROM can take the place of a competent teacher and no computer network will change the way government works.” He was an astronomer, a hacker, and author, and a computer geek.
  6. In 2007 Steve Balmer said: “There’s no chance that the iPhone is going to get any significant market share.” He was the CEO of Microsoft. 22Mark Spoonauer, 10 Worst Tech Predictions of All Time. Aug 7, 2013. Accessed online on Jul 19, 2015 at http://blog.laptopmag.com/10-worst-tech-predictions-of-all-time

Criticisms of Clayton Christensen’s Theory of Disruptive Innovation

  1. In her 2014 New Yorker article; The Disruption Machine: What The Gospel of Innovation Get’s Wrong,JillLepore argues that:
    1. The theory is based on handpicked case studies, and it is not clear that these case studies are provide a sound basis upon which to build a theory.
    2. What Christensen describes as “disruption” can often be more accurately described as “bad management”
    3. The theory of disruption is built on retrospective analysis, it is unclear how useful it is in predicting how events will unfold.
  2. In his 2013 blog post: What Clayton Christensen Got Wrong, Ben Thompson examined the theory of disruption in the context of Apple’s introduction of the iPod, and later the iPhone. He argues that:
    1. The theory works well when we consider new market disruptions, but fails when we consider low-end disruptions, in consumer markets.
    2. The theory fails because consumers do not behave rationally.
    3. The theory fails to account for product attributes that cannot be documented but which consumers prize highly, all thing being equal.
    4. Vertical integration is a competitive advantage in consumer markets, because it allows vertically integrated producers to exert control over product attributes that customers value, but which would be near-impossible to control using a modular production framework.

Closing Thoughts

  1. The ideas on which “disruptive innovation” is built are not inviolable and permanent laws of nature. Early stage investors and startup founders should subject them to testing on a frequent basis. Disruption works in different ways in consumer markets than it does in enterprise, or business to business markets.
  2. Startup founders and their investors should combine Clayton Christensen’s ideas with those of Michael Porter in order to build a more complete strategic plan that can stand the vicissitudes of competition from the startup’s peers and the reaction from mainstream market incumbents.
  3. Good strategy is not a substitute for good management. Good strategy does not make good management obsolete.
  4. Building a better mousetrap is not necessarily the path to disruptive innovation and winning the market in which a startup is a new entrant.
  5. Low end disruptions almost always begin with a product that is significantly inferior in comparison to the product embraced by the mainstream market. Low end disruptions also have to be simpler, cheaper or more convenient than the mainstream product.
  6. New market disruptions do not necessarily have to be less expensive than the comparable product that is embraced by the mainstream market.
  7. Disruptive innovation entails much more than technological disruption. Incumbents can compete with technological disruption, and they always win in those scenarios. To succeed, startups seeking to disrupt a market must design business models that support their effort to bring their technological innovation to market and make it impossible for the mainstream market incumbents to respond in a manner that causes the startup to fail prematurely.
  8. The kernel of disruptive innovation is an insight that the mainstream market has ignored.
  9. Beware of investment advice from subject matter experts as it pertains to potentially disruptive startups. Test your biases against what can be proved by the market niche that the startup is first going to enter.

Further Reading

Blog Posts & Articles

  1. What “Disrupt” Really Means – Andy Rachleff
  2. The Four Stages of Disruption – Steven Sinofsky
  3. Marketing Myopia – Theodore Levitt, original 1960 HBR article
  4. Marketing Myopia – Theodore Levitt, 2004 HBR update
  5. How Disruption Happens – Greg Satell
  6. Good Disruption / Bad Disruption – Greg Satell
  7. Did RCA Have To Be Sold? – L.J. Davis
  8. What Clayton Christensen Got Wrong – Ben Thompson
  9. Clayton Christensen Becomes His Own Devil’s Advocate – Jean-Louis Gassée
  10. The Disruption Machine: What The Gospel of Innovation Gets Wrong – Jill Lepore
  11. Disruptive Business Strategy: What is Steve Jobs Really Up To? – Paul Paetz
  12. Clayton Christensen Responds to New Yorker Takedown of “Disruptive Innovation” – Drake Bennet
  13. How Useful Is The Theory of Disruptive Innovation? – Andrew A. King and Baljir Baatartogtokh, MIT Sloan Management Review Fall 2015 Issue
  14. What Is Disruptive Innovation? – Clayton Christensen et al, HBR December 2015 Issue
  15. Patterns of Disruption: Anticipating Disruptive Strategies of Market Entrants – John Hagel et al

White Papers

  1. Time To Market Cap Report
  2. Startup Genome Report Extra on Premature Scaling [PDF]
  3. Netflix: Disrupting Blockbuster [PDF]

Books

  1. The Innovator’s Dilemma
  2. The Innovator’s Solution
  3. The Innovator’s DNA
  4. Seeing What’s Next
  5. The Lean Entrepreneur
  6. What Customers Want
  7. The Creators Code
  8. The Entrepreneurial Venture
  9. Disruption By Design

References

Any errors in appropriately citing my sources are entirely mine. Let me know what you object to, and how I might fix the problem. Any data in this post is only as reliable as the sources from which I obtained them.
I am paraphrasing Steve Blank and Bob Dorf, and the definition they provide in their book The Startup Owner’s Manual: The Step-by-Step Guide for Building a Great Company. I have modified their definition with an element from a discussion in which Paul Graham, founder of Y Combinator, discusses the startups that Y Combinator supports.
Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition.
Brant Cooper and Patrick Vlaskovits, The Lean Entrepreneur. Wiley, 2013, pp. xx.
Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition, pp. xviii.
Ibid.
Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition, pp. 16.
Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution. 2003, Harvard Business School Publishing, pp. 45.
Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution. 2003, Harvard Business School Publishing, chapter 3.
Startups building products for the enterprise customer should be able to develop an analogous framework, assuming one does not already exist.
Marc Anrdeesen, Product/Market Fit, Jun 25, 2007. Accessed on Jul 18, 2015 at http://web.stanford.edu/class/ee204/ProductMarketFit.html
In their report they describe the stages of a startup’s life-cycle as Discovery, Validation, Efficiency, Scale, Sustenance, and Conversation. The report covers the first four.
This is a risk for early stage investors as well as startups.
Theodore Levitt’s seminal HBR article “Marketing Myopia” first introduced this concept in 1960. You should read the original article as well as this update from 2004.
It is worth noting that Clayton Christensen’s analysis and research focuses on business-to-business markets.
Marc Graser, Epic Fail: How Blockbuster Could Have Owned Netflix. Nov 12, 2013, accessed on Jul 18, 2015 at http://variety.com/2013/biz/news/epic-fail-how-blockbuster-could-have-owned-netflix-1200823443/
See statements like: “Move fast and break things.” or “Let chaos reign.”
Amar Bhidé,The Questions Every Entrepreneur Must Answer. From The Entrepreneurial Venture, readings selected by William A. Sahlman et al. 2nd edition, pp. 65 – 79.
I have discussed economic moats here: Revisiting What I Know About Network Effects & Startups and here: Revisiting What I Know About Switching Costs & Startups
Adapted from Top 10 Bad Tech Predictions, by Gordon Globe. Nov 4, 2012, accessed on Jul 19, 2015 at http://www.digitaltrends.com/features/top-10-bad-tech-predictions/5/
Mark Spoonauer, 10 Worst Tech Predictions of All Time. Aug 7, 2013. Accessed online on Jul 19, 2015 at http://blog.laptopmag.com/10-worst-tech-predictions-of-all-time

Recap: My 3 Days at #PowerMoves.NOLA 2015

by

I checked in, and then got some coffee.
I checked in, and then got some coffee.

I rarely like to travel; I hate having to go through security. I hate going to conferences. Most of the time I come away feeling I did not accomplish what I set out to accomplish. On Wednesday morning I left NYC on a JetBlue flight. I was heading to New Orleans for the 2nd annual PowerMoves.NOLA conference. I had to change my plans to attend the 1st installment of the conference last year at the last minute. I am glad I was able to attend this year.

In this post I will highlight the work that PowerMoves.NOLA is doing, the startups that were at the conference as part of the program, and some of the conversations I had with founders, and other investors while I was there.

About PowerMoves.NOLA

PowerMoves.NOLA is a national initiative to deploy innovative ideas, fresh approaches, and an overall commitment to equity and diversity as a growth strategy to address the generational obstacles that prevent minority entrepreneurship. Leveraging the thriving entrepreneurial ecosystem, resources, and culture of New Orleans, PowerMoves.NOLA’s mission is to increase the number of venture-backed minority-founded companies locally and nationally.

Through its fellowship program, pitch competitions, and boot camp, PowerMoves.NOLA acts as a catalyst, providing early-stage and high-growth minority entrepreneurs with access to capital, advisors, and the support they need to succeed. The national conference events showcases some of the top minority entrepreneurs from around the country.

PowerMoves.NOLA’s objective is to make the national conference the premier event for minority entrepreneurs to support their companies, learn from experts, and build visibility of their products, and attract early stage investors.

PowerMoves.NOLA is an initiative of the New Orleans Startup Fund (NOSF), sponsored by Chevron, and in a promotional partnership with ESSENCE Festival™ presented by Coca-Cola®. 1Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.

PowerMovesNOLA Program Book
PowerMovesNOLA Program Book

While there is danger in the venture business in getting too far away from the crowd, it can often pay to be unconventional. Don Valentine, the founder of Sequoia Capital, told me to trust my instincts, which lets you avoid getting dragged into conventional thinking and trying to please others.

In order to outperform any given market, it is mathematically true that you must not essentially *be* that market.  In other words, a venture capitalist can’t outperform other venture capitalist if they act just like them. This may seem like common sense but you would be surprised how much herding happens anyway, since many people would rather fail conventionally than succeed unconventionally.

– Tren Griffin, A Dozen Things I’ve Learned From Michael Moritz About Venture Capital. Accessed on Jul 5, 2015 at http://25iq.com/2014/06/07/a-dozen-things-ive-learned-from-michael-moritz-about-venture-capital/

Day 1 – Wednesday, July 1

The flight from JFK was shorter than I had thought it would, I did not realize New Orleans is that close. I arrived in the morning, and had a bit of time to catch up on work before activities related to the conference began.

The conference began with a networking reception and dinner at the New Orleans Museum of Art. I spent my bus ride from the hotel to the museum chatting with Rachelle Oribio who runs the Techstars++ Mayo Clinic program. Before Techstars Rachelle worked at Defy Ventures, and before that she helped convince communities in the Amazon to give up cultivating coca and instead to grow coffee and cocoa. We had a great conversation about early-stage investing, and startups. Our conversation got most animated when we were talking about startups we both got to see up-close, but in which KEC Ventures did not make an investment. It was interesting to hear what they are up to now, after going through Techstars++ Mayo Clinic and how the vision has evolved into what I assumed it would become.

I also ran into Chinedu Echeruo. He is the founder of HopStop, which was bought by Apple in 2013. We have been corresponding by email for about 3 years, but have never met or spoken on the phone. It was great to finally meet him in real life. Also, I always have a lot of fun when I meet a Nigerian or a Ghanaian . . . They get my jokes about Nigerians and Ghanaians.

Before that I had been chatting with Nnamdi and Aaron from 645 Ventures and also with Karl Bell and Adrian Ohmer from Invest Detroit. During dinner we listened to a presentation by LISNR’s Rodney William’s. LISNR is a high frequency, inaudible smart-tone technology; a new communication protocol that sends data over audio. LISNR aims to eventually be a technology standard for user authentication, peer-to-peer communication, and secure data transfer for connected devices in the evolving internet of things. I had seen him pitch in NYC about 9 months ago, so it was great to see how much progress LINR has made since then. It is in the midst of raising a Series B Round of financing.

Next time I visit New Orleans, I will try to visit the New Orleans Museum of Art again.

New Orleans Museum of Art - Jul 1, 2015
New Orleans Museum of Art – Jul 1, 2015

After dinner I went back to my room, did some work, and then went to sleep around midnight.

There’s nothing more invigorating than being deeply involved with a small company and everybody’s betting against us.

Great venture capitalists love the process of creating companies and more importantly creating customer value. Venture capital is a service business. Making others successful is the driving activity in the work.  Finding vicarious joy in the success of others is essential.

– Tren Griffin, A Dozen Things I’ve Learned From Michael Moritz About Venture Capital. Accessed on Jul 5, 2015 at http://25iq.com/2014/06/07/a-dozen-things-ive-learned-from-michael-moritz-about-venture-capital/

Day 2 – Thursday, July 2

I was up early. At 4:00 AM. So I did some work, showered, and then I emailed the attendees around 5:30 AM to say I’d be down at Starbucks between 6:00 AM and 8:45 AM, if anyone wanted to chat. The response was overwhelming. I got to chat with about 20 of the founders who were attending the conference during that time as they stopped by to chat for a few minutes each. Through out the rest of the day, and the rest of the conference founders identified me by my obnoxious neon orange sneakers, and my puma t-shirt and my black baseball cap. I got to chat with lots of people I might not have met otherwise.

#Coffee&AMeeting @PowerMovesNOLA 2015
#Coffee&AMeeting @PowerMovesNOLA 2015
My Uniform - Orange sneakers + jeans, puma t-shirt, black cap
My Uniform – Orange sneakers + jeans, puma t-shirt, black cap

Some of the people who stopped by that morning to chat; the ones with whom I had conversations that went a bit in-depth on a specific question they wanted to talk through; Edward Morgan of Revitalize Charging Solutions – he has a sales pipeline of about $8.7M and described his revenue model to me. Of course, I immediately suggested he run an experiment to see if the market will embrace another revenue model that would make his business model more attractive to investors. He currently has a payback period of two months on each device, I suggested he should see if he could reduce that to zero. I made the suggestion based on what I have learned from a startup I have been working on since August 2010, and in which KEC Ventures is an investor. I also chatted with Rudi from Joicaster, K.G from Quarrio, Craig Lewis from Visage Payroll, Larry Lawal from HealthFundIt, and Toni Okolo from PracticeGigs. I also had a long conversation with Harold Jean-Louis from SmartCoos about the market for business-to-consumer apps designed to help parents educate their young children. We spent a lot of time chatting about opportunities abroad, especially in China.

I bet the baristas and other folks at SBUX must have wondered what was going on . . . Our table was packed, some people had to pull up more chairs from other tables because the 6 at our table were taken. I’m glad I hit send on that email instead of deleting it for fear of pissing people off. There was a lot of laughter. That’s always a good sign.

Around 8:45 I walked over to Champion Square with Aaron Holiday of 645 Ventures. He was a judge for the #EntergyAngelPitch so he wanted to get there a little early.

#Entergy #AngelPitch @PowerMovesNOLA
#Entergy #AngelPitch @PowerMovesNOLA

These are the startups that pitched – 3 of the 5 are startups I had not heard about before. 2Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.

  • bluField is an interconnected system of Bluetooth® beacon networks, which creates a high-resolution grid of a real-world geographic area.
  • FoodTrace is a powerful software platform providing food businesses with tools for next-level sourcing management. We help farmers and artisans sell more and buyers buy better. A platform built on proven solutions for businesses to locate and attract new customers, utilize data as insights and food trends for better strategy, and increase revenue with sharing tools for the value-added marketability of quality sourcing.
  • Joicaster is a video syndication platform that enables content creators to schedule, manage, and distribute live content across multiple platforms to yield larger audiences in a simpler cost effective manner. JOICASTER simplifies the process of syndicating live video to multiple online streaming platforms.
  • Lineapple turns smart phones into a mobile buzzer which in turn helps businesses increase profits by converting lost shopping time into new opportunities to increase and close sales. Lineapple is unique because it works inside the micro sales and non-revenue producing windows that are generally controlled by wait-times not during the already profitable active shopping time.
  • [N]tensify provides a branded in-app merchandise store as an additional revenue stream for mobile app developers, integrated via a software development kit (“SDK”). Ntensify creates apparel, plush, and other unique merchandise based on app designs. Ntensify provides a full service production chain, handling all customer data, payment processing, design, manufacturing, and fulfillment.

The #AngelPitch was followed by the #SeriesAPitch – 3 of the 5 are startups I had not heard about before. 3Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.

  • Maker’s Row is an online B2B marketplace that connects brands with US-based factories. Maker’s Row was founded in November 2012 and currently hosts over 75,000 brands and 6,000 US-based factories. For brands, Maker’s Row provides a transparent community for any size brand to connect with US manufacturers by viewing their factory profile and messaging directly through the Maker’s Row platform. For Factories, Maker’s Row provides a platform for factories to showcase their capabilities and generate inquiries and leads in our community of brands and designers
  • Quarrio is Conversational Analytics. Users ask questions in ordinary English and the system answers instantaneously in plain English with auto-generated graphs and charts. More importantly, the user can then ask follow-up questions and quickly drill down to the important information they seek. The software is a broad artificial intelligence platform that works with any enterprise data source, launching first to sales managers using salesforce.com. Quarrio has created a Learning Natural Language Interface to Databases delivered as a SaaS platform that enables ordinary people to do advanced reporting and analytics.
  • Upswing partners with colleges to provide an easy-to-use virtual learning center for students (for free) and a real-time comprehensive analytics for administrators. Each day, over 200,000 students have access to live, 24/7 tutoring via Upswing. Each student can choose which tutor to connect with among both their college support staff and Upswing’s coaches. Sessions take place online within Upswing. Each session is recorded, aggregated, and reported back to administrators so they can become equipped with the tools necessary to fight student attrition.
  • Partpic is an enterprise software solution that simplifies the search and purchase process of replacement parts using visual recognition technology. It’s as simple as 1. Snap 2. Discover 3. Purchase with Partpic’s API integrated on your retail website or mobile application. Partpic simplifies the part-search process by allowing a purchaser to simply snap a picture of the part she is looking to replace. Using a collection of visual recognition algorithms, Partpic matches the user-generated image with a part in our extensive database. It then returns the name of the part and its specifications. Partpic makes it easy. Consumers upload a picture of a part either via the company’s Partpic powered mobile application or the company’s website. Partpic handles identifying the part and only leaves the sales rep with the responsibility of confirming and processing the order for the consumer, eliminating purchase errors in the process.
  • Nexercise is a digital health company with the goal of disrupting the exercise industry with the only platform that provides personalized on-demand video workouts for any need to any screen anywhere. Sworkit, which is the consumer facing brand, has achieved over 1 million monthly active users with a 5X growth since January 2015 and see over 15K downloads per day. Nexercise is the first all African American leadership team to graduate from the TechStars accelerator in Chicago 2013. Sworkit is currently available on iOS and Android for both phones and tablets. They offer a “lite” version that is free and ad-supported, and a “pro” version costing a one-time fee that delivers an ad-free experience and enhanced customization. In Q2 2015, they are introducing subscriptions for both professionals and general users. Don’t quote me, but my sources tell me Sworkit hit the $100K revenue milestone for monthly revenue in June, last month.

I have been tracking Partpic since March/April 2013 when I saw Jewel pitch at NYC Seed. So I was not surprised when I heard the judge’s decision.

We had lunch after the #SeriesAPitch . . . I ate a lot – I usually do not eat very much, if at all. Shrimp and grits, more shrimp and grits, blackened pork chop with rice and beans, beef brisket sandwich, more beef brisket sandwich. I also talked with Nnamdi and Aaron about some of the startups, and possibly tag-teaming on due diligence in anticipation of their next round. I also caught up with Rudiger Ellis from Joicaster, he had come down for coffee at Starbucks early in the morning, so it was great to reconnect and chat about his experience attending the conference. It was his first time too. Danielle from Lineapple talked us into getting snowcones . . . shaved ice with syrup drizzled over it, helps cool down from the heat.

I decided to head back to my hotel room in order to make sure nothing work-related was falling through the cracks. Also, my wife decided to come down from NYC for one day, and I had not yet seen her since she arrived early that morning.

So, I did some work. Showered, and got ready for the cocktail reception that evening. It was hosted by Liberty Bank. On the bus ride over I sat next to Uchechi Kalu Jacobson of Wedocracy – before that I would never have thought I would be chatting with anyone anywhere about the logistical challenges involved in planning and having a Nigerian-American-Jewish wedding in Mexico. But, we did talk about that and it was helpful that I have been following “WeddingTech” for some time. Later that evening I met Peter, Uchechi’s husband at the cocktail party.

I went back to the hotel after the cocktail party – on the bus ride back to the hotel I got to catchup with Candace Mitchell from Techturized/Myavana who I have known since October 2014 when we met at Digital Undivided’s FOCUS100 in NYC. I told Candace about Indie dot vc when it launched. Techturized/Myavanna is in the 1st Indie.vc cohort. It was my first time seeing her since the program began and so I was eager to hear about the kinds of issues she and her co-founder are wrestling with now that fundraising is not as much of the desperate emergency it used to be.

Once at the hotel, I did some work and then went to sleep around 10:30 PM.

Day 3 – Friday, July 3

I woke up at 1:00 AM and did some work, mainly responding to emails . . . . and trying to fix appointments that had somehow fallen through the cracks because of a misunderstanding between me and Amy, my assistant. I also got caught up on news, and did a bit of reading. I emailed the #PowerMoves.NOLA attendees again, around 3:00 AM that morning. It had occurred to me that since it was Friday, and since I usually would be holding @KECVentures Investor Office Hours if were home in NYC, I ought to do the same @PowerMoves.NOLA. So I decided to hold @KECVentures Investor Office Hours @PowerMoves.NOLA, fuelled by Starbucks, from 6:00 AM – 9:00 AM. I had a large coffee with 3 shots of espresso. The barista thought I was crazy.

@KECVentures Investor Office Hours @PowerMoves.NOLA 2015, fuelled by Starbucks
@KECVentures Investor Office Hours @PowerMoves.NOLA 2015, fuelled by Starbucks

The most fascinating conversation I had during office hours was with Candace from Myavana. They are grappling with a problem that I think could form a great foundation for a ph.d thesis in combinatorial analysis – this would combine math, economics, finance, and business strategy. I suggested she chat with some of the graduate students in the Mathematics, Statistics, and Economics departments at Georgia Tech. There may be a ph.d candidate in one of those departments looking for an interesting problem to study who is also interested in this specific class of problems.

I also chatted with Sterling Smith. He and his team at Keystoke are building Sandbox, which is a system they believe will enable anyone anywhere in the world to build a mobile app to accompany an ecommerce store on the web. I expect to follow up with him when he visits NYC to try to meet investors, he’s raising a seed round.

Kofi Frimpong from Branslip also stopped by . . . I later remembered that I had read about him in 2012, and tried to connect with him then. At the time he was working on a different idea, mentoring high school students in the Philadelphia area to help them complete the journey from high school to college. Brandslip is different. It’s a social network for social media influencers and content creators.

Craig Lewis from Visage Payroll, and Samuel Lemu-Johnson from Sein Analytics also stopped by, though we could not chat for long because they were headed to an invitation only FinTech event from 8:30 AM to 10:00 AM. I was not invited to the FinTech showcase so I decided to use that time to try to catch up on some work in my hotel room between 9:00 and 10:00. That was a bad idea because I missed the bus to the next event, so I had to catch a cab. Fortunately I made it there on time.

These are the startups that pitched at the Morgan Stanley Fintech Showcase – 4 of the 5 startups that pitched are startups I had not heard about before.

  • eMoneyPool is an online community where members pool funds to borrow and save together. The concept is based on a centuries-old financial practice where your reputation within a community is your credit. Millions of people in the United States, and billions worldwide rely on money pools because they don’t have access to traditional credit, so they instead turn to each other and leverage the capital resources of a community. eMoneyPool has formalized this practice and created a high-tech solution that is efficient and familiar to our target market.
  • The municipal bond industry has grown significantly over the past 30 years, but the technology to support the industry has not kept pace. Munivestor offers financial software that tracks news, trades, and market events for more than 2 million individual municipal bonds. The information that we collect informs investors and assists them with maintaining their portfolio value.
  • Visage Payroll is a SaaS payroll startup established on the belief that small businesses shouldn’t have to pay to pay their employees or their taxes. There are 28 million small businesses in the US and 4M of those have less than 4 employees. We can help owners save an average of 10 hours/month and $1,800/year. Using back of the napkin math, that’s $50.4B in US small business savings and 280M hours a month being lost.
  • LendStreet combines credit counseling and distressed debt buying in a social lending platform to help distressed debtors proactively refinance existing debt into a low interest loan. Borrowers on our site do not receive cash; instead, the money invested by investors goes directly to paying the existing creditors at an agreed-upon discount. The discount is shared with the debtor in the form of lower debt, a reduced interest rate, and monetary incentives for financial literacy.
  • Sein Analytics helps investors, advisory firms, and issuers accurately value credit securities. Sein has developed a scalable cloud infrastructure specifically designed to manage complex mortgage and asset-backed securities (ABS).

You are the asshole who added me on LinkedIn and then did not respond to my follow up email!

– Toni Oloko, founder & ceo at PracticeGigs. PracticeGigs is in the current cohort of the MassChallenge Accelerator Program. Toni deferred starting his freshman year at Wharton in order to build PracticeGigs. We connected on LinkedIn in May. He joined me and other #PowerMoves attendees for coffee on Thursday. I responded: “I can tell we’ll get along really well.”

Time for the start of PowerUp Demo Day presented by #IberiaBank. @guydon is warming up the crowd with funny intros pic.twitter.com/JC3XsNjmZk

— PowerMovesNOLA (@PowerMovesNOLA) July 3, 2015

These are the startups that pitched at the PowerUP Demo Day, it was the culmination of the PowerUpBootcamp, which is part of PowerMovesNOLA programming. PowerUp is administered by PowerMovesNOLA in partnership with Startups Illustrated.

  • BIOEYE – puts a mass spectrometer in your smartphone.
  • Black&Sexy.TV – building the “Netflix + HBO” for the global black diaspora.
  • BrandSlip – a marketplace for social media stars to connect, collaborate, succeed and make money.
  • Callr – AI for connecting to every conference call you ever have to participate in, never dial into a conference call again. Ever. Techcrunch wrote about Callr.
  • Drivio – makes it less of a hassle for you to pay fines, and makes it easier for the government to collect fines.
  • HealthFundIt – improving the world’s collective health by connecting the people most passionate about a health condition with the scientists studying it so that people can directly support medical research in which they have a vested interest.
  • InstaSneaks – a social marketplace for the $100B+ street wear market. It enables peer-to-peer and business-to-consumer transactions.
  • Sandbox.io by Keystoke – build an ecommerce store on the web, then create a mobile version of your ecommerce store in about 10 minutes. Pay nothing, unless you actually sell stuff through the mobile app.
  • Legasyst – make interacting with the legal system as easy and seamless as using a mobile app.
  • NetworkingOut – a social networking platform that acts as a virtual athletic club for professionals.
  • Nomsy – food curation and discovery, to enable people with food allergies easily find food that suits them while on the go.
  • Paver – helps restaurants create, manage, and track their specials.
  • PracticeGigs – enables people to discover players and schedule practice sessions through a mobile social network. Initially focused on tennis in the Boston area.
  • ProSquire – a platform that enables small law firms to operate as if they have the infrastructure of their much larger peers.
  • RawShorts – a DIY builder for explainer videos, no need for a studio. If you know how to use powerpoint you know how to use RawShorts.
  • Revitalize Charging Solutions – is building a network of charging stations for electric vehicles. The charging stations also act as an advertising platform. Pilots underway with cities in Texas.
  • Roho – a media company that curates and distributes religious content. The initial product is focused on sermons for Black-American Christians.
  • RxCUE – enables patient savings through electronic medical rebates.
  • Solace – a seamless search and customization experience for home decor, initially focused on bedding, pillows, tapestries etc.
  • The Dime – makes local buying, selling, and promotion safer and more interactive with unedited video ads.
  • WedOcracy – a social wedding planning platform built by an engaged couple while they were planning their own wedding. The wedding hub of the future, today.

I spent some time chatting with Nichelle McCall, founder and ceo of BOLD Guidance. We first met at FOCUS100 in NYC, but never had a chance to chat at any length. So it was great to hear about what she’s trying to accomplish over the next 12 months. She’ll be fundraising soon. I wolfed down some lunch, and I am sure a few people must have thought I was scarfing down the food like there’s no tomorrow. I tend to eat very fast . . . I’d rather not waste time eating. I went back to the hotel and checked out. Then we headed to the Center Stage at the Ernest N. Memorial Convention Center for the #BigBreak Power Pitch – I arrived just as Dawn from Flat Out of Heels was wrapping up. These are the contestants.

  • Flat Out of Heels, LLC is the creator of the Flat Out rollable flat and the Flat Out shoe vending machine. Their rollable flats can be discretely carried for emergencies or worn all stay for stylish, durable comfort. Flat Out of Heels rollable flats are the solution to stiletto sore feet. Placed in venues like airports, nightclubs, malls, and hotels, where many women are wearing heels, the vending machines make it convenient to get emergency shoes when needed.
  • GemPhones is a fashion focused, jewelry inspired electronic accessory company that provides the most beautiful product designs in the consumer electronic industry. Every aspect of its product design is dual purpose, providing the look of a necklace and function for the usability of the device.
  • SmartCoos helps young children take advantage of their first 2,000 days and learn Mandarin, Spanish, French or English through 1:1 language sessions with a native speaker, e-books, and text nudges. Its product provides children with four critical web-based tools to learn Mandarin, Spanish, French, or English. Each child follows a tailored language curriculum based on the child’s age (0-2; 3-5; 6-8) in order to effectively use, coach, and reinforce the second language. Each child 1) Interacts with a native speaker on a weekly basis 2) Is provided with quality read-aloud eBooks 3) Learns the 200 most common words with baby sign language (“BSL”) 4) Are given daily text nudges, which increase the use of the language.
  • FashionTEQ manufactures a collection of smart jewelry for women. Its first product, Zazzi, keeps the user connected to her smartphone all day by notifying her of incoming texts, calls, emails, and more in a discreet and private display attached to a bracelet, pendant, or ring. The display provides imagery that lets the user know exactly what the notification is without having to access her phone.

I ran into Dawn Dickson, founder and ceo of Flat Out of Heels at the hotel when we went back to pick up our bags enroute to the airport. It was great to run into her since I had previously corresponded with her by email about a year ago through AngelList. We got to chat for about 10 minutes or so.

With Dawn Dickinson, ceo and founder of Flat Out of Heels, at the Hyatt Regency in NOLA after she won the #PowerMoves #BigBreak Pitch at #EssenceFest. Image Credit: Tasha Kersey Aoaeh
With Dawn Dickinson, ceo and founder of Flat Out of Heels, at the Hyatt Regency in NOLA after she won the #PowerMoves #BigBreak Pitch at #EssenceFest. Image Credit: Tasha Kersey Aoaeh

To close, for every founder who was at #PowerMoves.NOLA  and any founder who was not there, but wishes they could have been . . . This is one of the songs I listen to when I need to refuel my spirits after encountering obstacles that would otherwise knock me off my stride.

References

Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.