Community Event: Living on the Fault Line 10/26/00

Gaps, CAPs And Pragmatists In Pain
Geoffrey Moore Reveals The Secrets Of Managing For Value In The Internet Age

(Washington, DC -- October 26, 2000) According to Geoffrey Moore, the key marketing challenge for startups is positioning, and positioning means “getting your company put in the right category and making sure it's a category that you win. It also has to be a category that's valuable.”

Geoffrey Moore’s Step-By-Step Explanation Of Why Tech Stocks Fell Off The Fault Line Into The Chasm Like An 800-Pound Gorilla In March, But Will Come Back Like A Tornado. So Keep The Faith.

Step 1 The market realized that “the Internet is the most investable category ever.”

Step 2 There were a limited supply of Internet stocks and, at least in the beginning, they offered a limited number of shares.

Step 3 This drove up early valuations.

Step 4 Since companies are valued in comparison to other companies in related categories, the valuations of new companies escalated.

Step 5 Speculators increased the froth.

Step 6 The market absorbed enormous abuse. Dot.com after Dot.com created paper billionaire after paper billionaire.

Boom Now we’re in a correction period that may go on for a while, but the fundamentals are fine. Honest!

Moore is quite possibly the most recognized and respected pundit on business in the New Economy. He is founder of the Chasm Group and venture partner at Mohr Davidow Ventures. His books are bibles of high-tech marketing and management, including his newest, “Living On The Fault Line,” about managing for shareholder value. That was his topic tonight, speaking at an event for the Morino Institute’s Netpreneur.org, where he tailored the message of managing for value to an audience of over 1500 Internet entrepreneurs live and via Webcast.

Categories are essential because that’s what investors look at first when valuing a company¾not you and not your competitors. That comes later. In an area of disruptive technologies like the Internet, the most important question is how much wealth the new category can create. That sets the maximum amount of future unrealized potential, and managing for value is all about one thing¾increasing the unrealized potential of your company.

It applies to private as well as public investors said Moore, “When a shareholder buys your stock. They need you to increase the future unrealized potential of your company in order for them to sell at a price that is higher than what they bought it for. If, instead, you milk that potential to make numbers, you end up with a company that has less future unrealized potential; so, when they sell, they lose money. That's what we are managing for when we are managing for shareholder value.”

Unrealized potential can become realized value based upon a number of factors¾how well you execute, movement between categories, the speed of market acceptance for a new solution¾but when an investor is considering your opportunity at the early stage, he’s looking at two things: Gap and CAP.

Market capitalization is a function of two things: your share of the potential returns in the category and the time it takes for you to realize them. When investors value your company they discount for risk along both factors¾the difference between current returns and unrealized potential, and the amount of time you have to both realize and sustain the value. The Competitive Advantage Gap is the distance between you and your closest competitor. It affects the height of the value curve. [See Figure 1]

The Competitive Advantage Period (CAP) is your sustainability over time and involves factors such as barriers to entry for new competitors. The further it stretches out, the more the investor’s risk decreases. The more area under the curve, the higher the value, at least from a fundamentalist investor’s point of view, so you can gain value by extending Gap or CAP, but most managers focus on the former.

Said Moore, “The issue of sustainable competitive advantage is what gets lost in the shuffle of day-to-day management. We put a lot of attention on Gap, so product introductions get the entire company mobilized. Lower priced offerings and superior customer service, those are a little bit CAP issues, but things like patent positions, market share leadership or brand loyalty¾investments that take time to put in place¾tend to get the short shrift in highly competitive situations and this is where managing for shareholder value is the thing that rescues you.”

One reason why the time vector is especially important for netpreneurs is because all disruptive technologies have a unique adoption curve, ranging from innovators to laggards. [See Figure 2].

The breakaway happens when a technology is able to “cross the chasm” and gain acceptance by that bulge of pragmatist customers who have been waiting for proof of concept. When you do that, you have a real market instead of just a category. The best way to cross the chasm is to search out the niche markets of pragmatists in pain¾the people in the early majority who feel compelled to fix something they can't fix with existing technology.

That’s what Angie Kim, President and Chief Customer Officer of EqualFooting.com, and Brian Keane of Aether Systems are doing. Following Moore’s talk the three engaged in a conversation to apply the topics he covered to the real challenges of their two companies. Both seem have found their niche opportunities by addressing the “context” needs of customers.

All businesses perform two types of functions: core and context. Core functions are those that directly affect shareholder value, such as introducing new products. Context functions are necessary but they don’t increase value. For example, according to Moore, when Adobe made $300 million on their Netscape investment, their stock didn't move. Such investments make money, but they do little or nothing to increase unrealized potential. When companies are young, they spend almost all of their efforts on core functions, but, as they mature, they spend more and more of their critical resources on context functions¾the things that don’t increase value. That’s one reason why startups are more agile than the big companies they compete against.

Morino Institute founder Mario Morino picked up on this theme in his wrap-up to the event, tying it to another of Moore’s points, the difference between good revenue and bad revenue. It’s an important distinction for startups who find themselves, as Kim put it, focused on getting “any revenue.” Bad revenue brings in dollars, but costs so much in time, resources or money to get or maintain that it draws you away for focusing on core functions that continue to increase value.

According to Morino, an investor and former technology entrepreneur himself, “If you want to kill a company, get bad revenue. If you want to kill it slowly, get indifferent revenue. You must get business that counts. If you can’t get it, get the hell out because you are not going to make it."

Actually, it’s in the battle for core over context that Moore and Morino both see the real opportunities of the New Economy. Said Moore, “Context is really core in the wrong place. Can we just rearrange things so that we get everything in the right place? That's the ideal vision. If you think about this new economy, it's a network of cooperating companies creating end-to-end solutions in which nobody would do context, and everybody would do core. It creates higher returns for investors because every company is spending more of the investor's dollar on core. It increases flexibility because you have multiple sources of support. It creates greater value for customers because you have more minds working on the problem than just yours, and, furthermore, better minds are working because you don't put your best minds on context.”

This potential is why he remains so bullish on the sector, even in areas that are currently out of favor with investors like B2B markets. “Do not let the current financial markets confuse you,” he said, “The Internet is the greatest category that has ever hit the planet, and the fact that you are in an Internet-related business is a very, very good thing.”