If the ads on the websites and in the apps you frequent disappeared tomorrow, would you miss them? Can you think of any specific sites or apps, other than search, where introducing ads improved user experience?

I happened upon these questions a few days ago while preparing the opening remarks for a FutureM event my startup, Shopximity, organized here in Boston. I was surprised I couldn’t think of any examples. I asked my co-workers. I asked friends who were website publishers, mobile app developers, and adtech execs. They could not think of any examples either. Then it hit me: display ads are not just content. Display ads are bad content.

This year in the U.S. advertisers will spend $24 billion on display ads. Two hundred advertising intermediaries, which control hundreds of thousands of servers and manage petabytes of data, will deliver 5 trillion mostly irrelevant ads that will reduce the user experience of 215 million people on average 16 billion times per day. Never has so much computing power been applied with such disastrous effects. It’s time we do something about it.

Most ads don’t deliver value, which is why six in 10 people surveyed by AdWeek actively ignore them. Average click-through rates (CTRs) have dropped in half from the small 0.2% in 2007 to the dismal 0.09% recently, as reported by DoubleClick. Some choose not to see ads altogether: AdBlock has more than 20 million active users. To deal with this, rather than improving user experience, the display advertising industry is waging a war against consumers. In the words of Seth Godin, “Advertisers distract users; users ignore advertisers. Advertisers distract better; users ignore better.”

More intrusive ad formats and more sophisticated targeting risk alienating users and further eroding their trust. The poor user experience of display advertising is an externality that ultimately hurts publishers and advertisers. They, and not the invisible ad intermediaries, have the relationship with users and to them accrues the good will and wrath of users also. I shudder to think how much worse user experience could get when the display ad industry reaches the $50 billion mark in 2-3 years. The vicious cycle has to end. We have to stop talking about display advertising being relevant and valuable and actually make it so or stop doing it.

Dozens of startups, Shopximity included, have taken on this challenge and are re-thinking display advertising using better ad formats, effective yet respectful targeting, and cooperative ways to engage users. In fact, not a single company presenting at the Mobile Marketing Frontiers event I am leading on Wednesday morning is doing traditional display advertising. The event will be a great chance to see what’s next in marketing. The same is true of many other FutureM events, which is why I’m so excited about this week. If you haven’t registered for FutureM, now is the time to do it. (The discount code “Shopximity” will save you 20%.)

For the display advertising players, the message is simple. You are at a Darwinian moment. You have forgotten that the user is ultimately in control. It is simply not OK to operate in a manner that is net-negative to user experience. Own up to your responsibility and figure out how to deliver valuable and contextually relevant ads. Hurry, because the startup across the street is a year ahead of you.

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Facebook is mission-critical infrastructure. Not for me and not for you either, since you reading this makes the odds of your age being greater than Zuckerberg’s quite high. However, for millions of people between the ages of 10 and 23, Facebook is critical to their lives. The reason? Homework.

I’m old enough to have stopped doing homework a decade ago, but not old enough to have kids in this age range, and thus for me to see this it took listening to a panel of four high schoolers and one college student at the Future Forward conference in Wellesley, MA, a couple of weeks ago.

Everyone did homework the same way. The editor of choice was Microsoft Word, “because that’s the only format teachers would take assignments in.” Then there was a browser with multiple Facebook chat windows open. Have a problem with homework? Ask a classmate who’s doing the same assignment. Your classmates can’t help? Ask a friend in an upper class. Simple, no? I wish I had it that easy when I was in high school. Instead, I had to walk through fog & drizzle up the hill (both ways) then climb towards the roof of a haunted thirteenth century Welsh castle… I digress.

The reason why Facebook is such a good fit for people of this age group and especially for high schoolers is three-fold:

• People in this age group move in cohorts and have shared experiences in class. This base of shared experience provides a solid foundation for a social network, but also makes the social network useful for solving problems such as doing homework and making recommendations with regards to fashion, music, dating, etc.

• People in this age group do not have other social networks that could compete in size and relevance with this one. So there is no need to think about who you “friend,” i.e. connect with, on Facebook vs. anything else. It is no surprise that on the panel nobody had heard of LinkedIn and only one person knew of a friend who used Twitter (what for, he had no idea or interest in finding out).

• People in this age group live a geographically constrained life, making geo-based networking tools largely irrelevant. No surprise then that not one of the five panelists used Foursquare or Gowalla. In fact, only two knew what Foursquare was and none had even heard of Gowalla.

What couldn’t be done with Facebook, the group did using texting and e-mail. E-mail served three main purposes: communicating with old people (teachers), sending files, and personal information management. That last bit was interesting: they’d e-mail files to themselves in order to have them in one place where the information would be searchable and available from any machine.

Yesterday morning Andrew Bosworth—co-creator of the newsfeed and one of the sharpest tacks at Facebook—introduced the new Facebook messaging system, which integrates SMS, e-mail, instant messages, and Facebook messages, and, finally, allows Facebook users to handle attachments. Checkmate. Facebook just became the complete mission-critical infrastructure for getting homework done. If the plan works, it will add some more billions to the valuation of the company. And, likely, get the privacy watchdogs to increase their scrutiny—as there is now little information about the lives of teens and college students that Facebook won’t see.

Who wants to bet on whether Facebook will replace Microsoft Word with a simple, integrated editor with built in sharing & chat?

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A couple of days ago, more than two hundred founders, CEOs and marketers got together with some very sharp thinkers to talk about making startups successful under the umbrella of FutureM—a week-long series of events about what’s next in marketing.

MITX, which I’m honored to be on the board of, organized FutureM with the help of dozens of businesses. I loved the idea of FutureM and decided to put together an event on customer development because the most common problem I see in companies I work with through FastIgnite is poor linkage between product development and marketing, which is often combined with premature scaling to boot. Customer development is the best methodology I know of to deal with this problem in early- to mid-stage startups. Steve Blank coined the term 8+ years ago, and the methodology has been well-tested and much improved over the years.

I partnered up with General Catalyst Partners to organize the event because they are a venture firm that gets the combination of agile development and customer development—it’s practiced in many of their portfolio companies and plays a key role in how they engage with seed and Series A startups. (Being a part-time exec-in-residence at GC made it easier to pitch the crazy idea of putting together an excellent customer development event on a night when there were at least four other major events going on in town.)

Gus Weber from Microsoft’s NERD Center joined our group and became the event host. Next came the keynote speaker—Bob Dorf, a known marketer, six-time founder/CEO and investor in two dozen startups who is also Steve Blank’s co-author for the next version of the customer development “user guide,” tentatively titled, Customer Development: The Second Decade, due next spring.

This is how our eponymous event was born, and here it is by the numbers…

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The best way to get a sense of the event is to look at Bob Dorf’s slides and the event video. If you’d like to learn more about customer development, read Steve Blank’s blog and Eric Ries’s blog.

I will close with a final comment from Bob Dorf:

“Many of the audience questions seemed to turn one way or another on the point that “gee, this is hard, pivots are hard.”  So, I accomplished my mission. Entrepreneurship is hard. Damned hard. And if you buy the recent research that one in 3,000 “cocktail napkin” business ideas turns into a business that hits out-of-the-park valuations, that sets the bar far higher for every entrepreneur in startup mode who is passionate about hitting it out of the park.  Anyone else should really go get a comfortable W-2 job someplace.  Long before I met my wife of 33 years, I lost a very serious, hot live-in girlfriend because she said (literally) “I think you love your business more than me.”  She was probably right and I hope she found a wonderful W-2 guy.  Startups are hard. I hope that the Customer Development process and lean startup discussions gave the many passionate entrepreneurs in the room a hint at a roadmap to ease their travels.”

Let me know your thoughts on the event or customer development in the comments or at @simeons.

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History repeats itself, it seems, because the defining technology battle of this decade is going to come straight from the 80s: it’s hardware versus software. [tweet] Every decade brings substantial advancements to both software and hardware, but in certain decades the strategic importance of one versus the other shifts dramatically in many segments. I’m using the term hardware loosely to include software wrapped in metal, which is still what companies such as Cisco and EMC live off of. Here is an extremely brief recent history of computing:

• 1950s: the decade of mainframes (go IBM!)
• 1960s: the decade of minis (go DEC!)
• 1970s: the decade of change (DEC ships VAX, Intel ships microcomputers)
• 1980s: the decade of the PC with the clone wars and the commoditization of hardware, assisted by a then little-known company run by a Harvard dropout by the name of Bill Gates
• 1990s: the decade of telecom/network hardware (Cisco goes public in 1990) and Internet software
• 2000s: the decade of storage appliances and smartphones on the hardware side and large-scale Internet software

The period between 1950 and 1980, and the business models of the dominant players, were about hardware. In the ’80s, for the first time, software stood on its own and started taking a significant portion of spending at the expense of hardware. In the ’90s there was more of everything: servers, routers, storage, and during Bubble 1.0 large enterprises wanted at least one of every type of Web-related software. During the millennium decade, hardware made big advances through smartphones and in the fast-growing storage business, while companies were able to spend less on software thanks to broader adoption of open-source technology. This decade will be defined by a reversal of this trend, one that will mimic the ’80s in terms of hardware commoditization.

Most hardware doesn’t matter because some hardware matters a lot. [tweet] Apple owns the top of the PC pyramid through its brilliance in hardware design and through the software leverage of OS X and iTunes. This forces all other PC manufacturers into a deadly, low-margin competition in the low and mid tiers.

Netbooks accelerate the race to the bottom. [tweet] In a short period of time, netbooks have become a big part of portable shipments. Pushed by subsidies from mobile operators wishing to lock users into multi-year plans, netbooks will become “smartphones with larger screens.” Netbooks are great for browser-based applications, which makes the netbook OS and hardware even less important. That’s good, because there isn’t much margin in a $300 netbook.

Virtual appliances replace physical appliances. [tweet] For many years, appliance vendors have extracted additional margin by slapping their logo on a commodity appliance. CIOs want none of this. Virtualization and advancements in distributed systems make it possible to run all kinds of enterprise applications and infrastructure services such as storage, networking, and security on commodity hardware. Commodity again means lower margins for hardware manufacturers, including companies such as EMC and Cisco, who have reacted by shifting their focus to service businesses and pure software packaging.

Cloud computing makes hardware less relevant. [tweet] This decade will be defined by a migration to cloud-based computing for everyone from consumers to the largest of enterprises. On the enterprise side, the move is driven by the desire to lower costs and add flexibility. On the consumer side, it’s driven by the need to manage data and applications across several devices (laptop, netbook, e-reader, mobile phone, etc.). Cloud-based architectures buck a multi-decade trend and emphasize service level agreements (SLAs) that come from software as opposed to hardware. Instead of powerful, expensive servers, high performance and availability come though horizontal scaling of unreliable, cheap servers combined with new distributed software architectures. On top of this, the very large cloud vendors will operate vast server farms which, increasingly, as Google does today, will deploy commodity custom servers. Even less margin for the major hardware players.

Software begins to dominate as the driver for mobile device purchases. [tweet] Historically, back in the now distant days when mobile phones were primarily used for calling, consumers chose the phone first and then went along with whatever software came with the device. RIM was the first to change this with the Blackberry. Then came Apple’s iPhone. In both cases, these were systems-hardware and software came together and were supported by additional desktop and server software, namely the Blackberry desktop client and Blackberry Enterprise Server and iTunes / iTunes Store. What is more important? The design of the Blackberry device or the fact that it’s the best mobile e-mail machine on the planet? Would you have bought the iPhone if it ran Motorola’s clamshell software? Google’s Android mobile OS pushes the divide further. I’m not suggesting that there won’t be really successful mobile hardware innovations. There will be a continuous streak of delightful innovation in devices. I’m simply arguing that, in this decade, the relative importance of mobile software and the third party ecosystem of software products and services will dominate.

Tablets are the obvious dark horse on the hardware side. If the human I/O problem is solved, we could see a radical shift in form factor that should exceed that of netbooks. I guess we won’t know for a few years. Even if Apple “does an iPhone” with its iSlate, it will be a long time before their volume meaningfully affects the landscape. Steve doesn’t like to sell things cheap.

There is one less obvious dark horse that hasn’t been named yet so let’s call it Rackware. [tweet] The “commodity custom servers” in data centers I mentioned above will look quite different from the typical servers that go on racks today. Google’s already do. In fact, they may combine CPU, memory, storage and I/O in very different and more variable ways than current servers for heat density, workload optimization and I/O virtualization reasons. Also, they may come not in server units but in rack units or other types of units (such as Google’s containers) that make deployment and management, including power and cooling, much cheaper and easier. It is foreseeable that a company could create sufficient new intellectual property in this area-both on the system and supply chain management side-to command premium margins for a period of time. Dell is a good example of this: one of the key differentiators they had in the early days was a supply chain patent that covered the just-in-time manufacturing of customized PCs.

The large scale value shift from hardware to software will have significant ramifications for innovation, venture capital, and investing. It will be an exciting decade.

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[Updated 11/18/09, see below] This post is about how to get a better deal from VCs investing in your first round of financing. It is also about how to make the deal into a win-win. The idea for the post came from an exchange with @bakespace about some of the resources for entrepreneurs on FastIgnite.

This is About Series A Deals

Seed investments can be all over the map in terms of size ($50K – $1M+), structure (convertible debt or common/preferred equity), valuation, and investor rights. It’s hard to make generalizations about seed deals.

First-money-in Series A deals, on the other hand, tend to be much more cookie-cutter. Before we talk about why this is the case, let’s put a rough definition around the types of Series A financings I’m referring to:

• Not much has been raised previously—at most a few hundred thousands and ideally nothing.

• The product has not been (fully) built.

• The size of the round is at least $3M but preferably larger.

• You are talking to professional VCs with funds > $100M.

These deals tend be cookie-cutter because they are driven more by the cap table (the list of shareholders in a startup and how many shares they own) than by what the company might be worth independently.

What is Your Startup Worth?

This is a question entrepreneurs think a lot about. They come up with all kinds of arguments for justifying their notion of value pre-funding. The trouble is, most of the arguments are bogus because they miss an important point: a company that needs several million dollars today to build a business is not worth much at all without the dollars.

Say the goal is to stick a flag on top of Everest. You are a great alpinist but you have no money for the expedition. Your friend Bob loves what you do, happens to be excited about you climbing Everest and has tons of dough. Which is more important? Your ability to climb or the financing? You ability to climb is certainly scarcer and hence commands a certain premium, but in the end it’s a partnership. Money without an alpinist can’t get to Everest. An alpinist without funding can’t get to Everest either. It is the combination of the scarce talent (climbing) and the resources to make this talent productive (the dollars) that creates the value.

The Series A Valuation Process

What this means for your Series A deal is that, to a large extent, the value of your company is going to be reverse-engineered from the cap table. Here is how this works:

1. You and your investors agree you need $X ($3M, for example)

2. The investors want to own a certain percentage post-financing (I%) (2 x 20% = 40%, for example if two VCs are syndicating the deal)

3. The post-money valuation is now $X/I% or $3M/40% = $7.5M

4. You negotiate the size of the option pool (P%) (25%, for example)

5. Your true pre-money valuation (what the founders’ stake is worth) is $X*[(1-I%-P%)/I%] or $2,625,000.

There are two things to notice about this process. First, at no point did it require justifying the value of the startup. Second, the margin for negotiation is somewhat limited as (a) the option pool size should be budget-driven and (b) most investors, rightly or wrongly, are pretty set on the percentage ownership they require. (The reasons for this have to do with the business models of venture firms—which are too complicated to cover here.)

Without meaningful deal competition, you’ll be unlikely to affect the investor(s) target ownership percentage. So if you really want to get your VCs to take a lower percentage, you’ll have to work a lot harder to generate interest from multiple firms. Either that, or you’ll have to … Next Page »

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