Orville McDonald

Random thoughts on technology and business

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Creating and Sustaining Profitable Growth

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Clayton Christensen always has interesting strategy papers.  I came across this presentation that has some useful information for those who are focused on bringing disruptive technologies to market.  Some items might be considered contrarian.  For example, when searching for the right business model “good money is impatient for profit, but patient for growth.” (Slide 26)

http://www.slideshare.net/lionzshare/clayton-christensen-world-innovation-forum

Talk to you soon,

Orville | Twitter: @orville_m

Written by Orville McDonald

November 30, 2012 at 1:46 pm

Posted in Strategy

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What makes a technology game changing?

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It often feels like I can’t read about a technology without hearing that it is game changing.  I personally love that technologists are always trying to push the boundaries of what has been done before but is everything really game changing?  Furthermore, if everything was game changing then we would have more new multi-billion dollar companies than we could keep track of.  So to provide some guidance, I often remember something a Senior Director at Microsoft once said.

Note: I currently work for Microsoft although the opinions expressed here are my own and do not reflect my employer.

Innovative Business Models

Google

Search engines have been around from the earliest days of the Web.  Conventional wisdom was that search results should not be polluted with advertisements.  Google found a way to make advertisements relevant for searchers while also making them a must have for online businesses.  This market making opportunity became a fountain of money for Google.  Furthermore, the network effects from having the searchers and advertisers has proven to be a competitive advantage that is difficult for others to overcome.

Partner Ecosystems

Windows

It is almost cliché to discuss creating platforms in the software business.  Often startups try to create the platform before they have users.  The original king of software platforms has to be Microsoft Windows.  When most computer systems were closed and had different integration methods, Microsoft created the standard software platform with Windows.  This decision created an ecosystem around Windows meaning that to use the most common applications (the old term before we started saying “apps”) you had to have Windows.  Even in the mobile era Windows is still critical for most people to accomplish their computing needs.

Innovative User Experiences

User experiences are continuously changing so I’m referring to a significant change in user behavior.  When I was an undergraduate I created a secure MP3 format assuming one day people would pay for music.  Although I was proud of my project, Apple clearly saw a larger opportunity.  At that time people logged into their favorite peer-to-peer application and searched for songs.  Sometimes the songs were mislabeled, poor quality or were a virus.  Then getting the songs onto a MP3 device was another headache.  Apple created an end-to-end model using iTunes to get quality songs with less effort and then syncing with iPods for portability.  They took care of getting the songs legally in a more efficient manner.  iPhone and iPad followed this model creating digital content strategy that is being used by other companies and grew Apple’s value considerably.

 

So there it is.  A criteria for determining if a technology is ground breaking.  It should be noted that these things are clearer in hindsight.  It will be interesting 10 years from now to look back and see which companies would be on this list.

Talk to you soon,

Orville | Twitter: @orville_m

Written by Orville McDonald

October 13, 2011 at 7:56 pm

Posted in Business

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Facebook Valuation: Some Context Behind the Numbers

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facebook

Over the past week there have been numerous articles, blog posts, news reports and conversations about Facebook being worth $50 billion.  Some say it is too high while other say it could be a bargain.  The one thing that is common is that there is not a lot of information available but there is a lot of speculation.  However, with the little bit that is known the valuation could be put in a better context.

The Fundamentals

It is estimated that Facebook’s net income for 2010 was up to $500 million (extrapolated from reports of their first 9 months of $355 million) on $2 billion revenue.  That would make Facebook’s P/E ratio 100.  This is significantly higher than other public internet companies like Google (25) and Yahoo (22).  If it were treated like a fixed income security it would yield 1%.  3-year Treasury Bonds (my proxy for the risk free rate) are yielding 0.98% (1/7/2011) so Facebook would not provide a great return for the additional risk of an early stage company with little financial disclosure.

From a fundamental perspective it makes sense why fundamental investors would want to unfriend Facebook.  But is this really the right way to value a growing internet company that has unprecedented reach?

What Investors are Really Buying???

Growth… but what does that mean?  With the deep level of user engagement and potential profit these users represent there are other metrics that could be used to value Facebook.  Long-term value of users would give a better perspective of how much Facebook should be worth.  At between 500 – 600 million users, the latest valuation would represent $83 – $100 per user.  A key question is can the company earn at least this much for each user over their lifetime with the service.  In 2010 earnings on average was $1/user on revenue of $4/user.  It is well known that making money is not a priority for Facebook at this time so it will be interesting to see how quickly they can grow earnings per user, because the users won’t be around for 100 years to recoup the money. Smile

There is also the question of how many more users are there who could join Facebook in the future.  Current stats show that 2 billion people are on the internet so there is still a lot of upside for growing the number of users.  User count could theoretically double which is crazy to think of.  I would guess that the incremental cost of adding users would be cheaper than the first few hundred million as they have economies of scale.

Overall there is room for Facebook to grow revenue, earnings and users but at the current valuation they will have to execute really well to justify the valuation.

How Does Goldman Sachs Fit Into This???

gs

Goldman Sachs’ (GS) investment provides credibility to the $50 billion valuation but there are also a lot of benefits for Goldman as well.  Direct ownership of Facebook stock gives GS the upside of Facebook stock when it goes public and the ability to earn fees from others who want the stock so badly they will pay fees to invest in the Facebook special purpose investment vehicle.  Assuming Facebook matures to a similar market cap as Google, GS shares could increase 3-4x in the future.

Yet the real benefit are the intangibles.  Similar to the British Petroleum deal in the 1990s, GS proves that it can move a large block of shares for an in demand company.  It also gives it favorable access to a company that is likely to become increasingly important in the technology field.  Secondary offerings, M&A and advisory work all carry future fees.  Plus the additional access in the social media space will improve their institutional knowledge making it easier to make money from proprietary investing, research and seeking new business.

Final Thoughts

No doubt about it, Facebook’s user base and valuation are growing quickly.  Ideally if you are “investing” it is better to get more details so you can do some due diligence.  However, if you have a few million to “speculate” think about why you are buying the stock, look at the information you have in a greater context and then make your decision.  Value is different for everyone so you have to make your own call on value.  There are several more techniques, that could have been used for this analysis as well.

Talk to you soon,

Orville | Twitter: @orville_m

Written by Orville McDonald

January 9, 2011 at 8:43 pm

Phone App Pricing Beyond $0.99

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Originally posted: 4/20/2010 at http://blogs.msdn.com/b/orville/archive/2010/04/20/phone-app-pricing-beyond-0-99.aspx

 

As a buyer of phone apps this is a blog post that I may one day regret but it is worth writing.  I have often wondered why most phone applications sell for $0.99 or less including free.  There are probably several reasons for this but my feeling is that most developers just follow the common price of other apps.  Developers who create compelling apps should be able have profitable marketplace success so they can build even more successful apps.  I know that a lot of apps are free to get broad distribution and are funded by ads.  Ad-supported business model is a good one but I want to provide alternative pricing strategy for developers to consider.  In this post I will write about a different way to set a price for apps.

Let’s start with the issues with some common pricing strategies.  Some of the most common pricing strategies that I have heard of include matching the competition and “cost-plus.”  Both of these options have faults.  Matching the price of the competition does not reflect the value of your app.  If the competition has a better app no one will purchase your app at the sane price.  However, if you have a better app it will not get as much money as it could have gotten and will also leave the impression of being of similar quality to the competition.  Cost plus some “fixed return percentage” as a pricing strategy is not driven by customer value and could result in an overly expensive price.  Phone app development is primarily has fixed costs and would require a clairvoyant sense of how many apps will be sold to correctly determine the return percentage.

When setting a price for an app one should focus on the value it provides customers.  Even if the developer’s focus is not on making a lot of money it is still important to understand how customers will value their app if it is going to be successful.  There are a few steps for determining the value of the app to customers:

  1. Identify your customer.  This sounds obvious but it is important to recognize who will buy the app.  Note that there can be more than one customer group, all with their own needs.
  2. Assess the app’s value to customers.  Do some customers find more value in your app than others?  Are there a few things you can do to make your app more appealing?
  3. What takes away value from your app?  External factors will impact how valuable your app is to customers.  Availability of substitutes, learning curve, alternatives to spending more time on the phone, etc.

When these 3 steps are combined you have a better estimate of how much you should charge for your app.  As an example, we will use an imaginary game “Foo.”  Foo is enjoyed by both casual and hardcore gamers.  Hardcore gamers are willing to pay for advanced levels while casual gamers are not.  For the casual gamers they can get a trial version while the hardcore gamers will pay for a more advanced game.  Sometimes the phone app may be free but there is a cost for a service that powers it.

Even though this is a basic introduction to pricing strategy I hope this helps you determine the right price for your app.

Talk to you soon,

Orville | Twitter: @orville_m

Written by Orville McDonald

January 9, 2011 at 1:03 pm

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