The Underlying Impact of the “Apps” Phenomenon on VC-Backed Software Startups

5/6/10

New smartphone applications (“apps”) are being developed at a rate of nearly 1,000 new titles a day. While Apple’s brilliance in cultivating the developer community receives much of the credit for this incredible phenomenon, it has also ridden the back of the global economic meltdown coinciding with the rise of the iPhone.

“Huh, come again,” you say? That’s right, the storm that wiped out so many budding software companies was so immensely beneficial to the growth in iPhone sales that even Steve Jobs probably never imagined its true transformative power and the permanent changes it would cast upon the software industry landscape.

Who among us doesn’t know someone who joined a software company in the past five years only to see their stock options plunge under water as a result of a cram-down financing, layoff, or outright bankruptcy? Or to put it a little more bluntly, who among us knows anyone left standing whose equity value wasn’t substantially wiped out? When something like 99 percent of developers who were being extrinsically motivated by stock options have seen their paper wealth get crushed, many have begun to question whether they’d been sold on a phantasmagorical dream like so many Klondike prospectors 150 years ago. Some of the walking wounded began searching for—and many have already found—a compelling alternative to the conventional startup company. Tens of thousands have launched their own app development and publishing businesses.

On the one hand, the consequences of this blight upon common stock value has caused many developers to seek higher ground in the form of competitive salaries and benefits, and to be less charmed by the allure of stock option certificates that may yet again turn out to be useful only as wallpaper. Even in the best economic times, the odds against stock options turning into real worth were already long. After a meltdown like the last one some are willing to bet on Dante’s lounge offering frozen drinks before they’ll bet on stock options again. The older dogs also remember that an economic downturn hits the entrepreneurial economy with tectonic force about every six to 10 years, taking out entire ecosystems of startups with them.

This may be good news for the Microsofts and Oracles of the world who can afford to offer higher salaries and attract software talent that previously would have opted for the upstart venture where they could play a more significant role, potentially create greater wealth for themselves, and not just be a “cog in the machine” of a giant enterprise. Indeed, finding developers to join a startup that has an insignificant war chest, no 401K, and a health care plan that relies on employees obtaining their own coverage is just about as hard as I can remember it ever being in the over two decades that I’ve been working in, leading, and investing in technology startups.

But there is another, perhaps more significant factor at work. If you know something about the psyche of software developers, then you should know that it is rarely about the money for them. Developers are “creatives” who thrive on knowing that the product they are building with their blood, sweat, and tears is going to be appreciated, if not loved by its users. The best way to kill a developer’s enthusiasm and creative energy is to have them work on a product for three years and then kill it before releasing it to the marketplace—something which happens with unfortunate frequency at the large enterprises. That kind of thing stings a developer’s sensibilities even more than bonuses or stock options foregone. For entrepreneurially-minded developers, the prospect of working on a project with 3,000 other developers is almost as numbing, and hence so many find the startup path undeniably more attractive. Under normal market conditions, anyway.

This developer’s “itch” needs to be scratched above all else. The desire to get a product into market that people will use and love. Along with that, the desire to get immediate feedback so that improvements can be made. Self-publishing a rapidly-deployed app scratches this itch faster and harder than anything you can do working at a big company with process-loving product managers, the goons from marketing and finance dictating the features they want you to build, and a board of directors detached from the day-to-day reality of the company.

The apps phenomenon has created a nearly-Utopian business world in which you don’t even need to build a “real” company with a sales force, funding, and an accounting department—things which are often beyond the capabilities and passions of the software creator type. With an iPhone App Store, your creations can be downloaded by thousands of users within days of completion. The entire creation cycle may be only days or weeks, occasionally months. In any case, an effort measured in two- or three-digit man-months and five-digit funding from Credit Card Venture Partners, not four-digit man years and requiring eight-digit VC funding rounds.

Often developers don’t even bother to incorporate or raise any capital to launch their apps publishing companies. Launching an app company is practically as easy as watering your plants. No interviews or negotiations, no office politics with the sales team, no commute, no office hours, no arguments over what kinds of snacks to stock the kitchen with—no fuss, no muss. A savvy, entrepreneurially-motivated developer can be in business, scratching the all-important itches in a matter of weeks. And thanks to the efficient marketplace distribution mechanism of the App Store, making a living off this becomes a possibility. The more apps you code the more money you make, and coding is what you love to do.

As every Girl Scout learns at the cookie sales table, “if you want to make a million dollars, come up with something you can sell for $1 and get a million people to buy it.”

So, among the many contributing factors to what’s broken with venture capital has been added this problem that the shiny object attracting top talent today may no longer be the promise of building massive wealth through stock option accumulation, but rather the instant gratification and “fail fast” modality of self-publishing apps. Even a mediocre developer can strike upon a super-popular iPhone app idea and be basking in the glow of massive user adoption, notoriety among peers, and even cash flow, very quickly. How do you compete with that? VCs had better start figuring out how to create work environments that appeal better to developers’ intrinsic motivations than the unreliable extrinsic motivator of stock options, especially after a wave of gloom like the one that hit our industry over the past two years.

Apple’s dual innovation of the iPhone device and the App Store distribution model combined with an economic blight upon software companies and their investors, the massive shift in time that users are now spending staring at their palms instead of a desktop or laptop screen, and the momentous influx of new platforms like the iPad and Google Android enabling even more opportunities for apps developers, have all come together to create a perfect storm in the venture capital business which will spell the demise of many VC firms and the less efficient VC-backed startups. It will be interesting to observe the new landscape after the economy completes its recovery and the waves die down again.

The silver lining to this circumstance—at least from the entrepreneur’s perspective—is that whether you’re talking about a one-man self-publishing apps shop or a five-person “software company,” thanks to the widespread availability of SaaS-based platforms—from development platforms to telephony and accounting platforms—it has never before been this easy or this quick to launch a company on absolutely minimal funding. Even three years ago, it was difficult to imagine a significant software company launching on so few resources and without first surviving the gauntlet of getting at least some angel or VC funding.

This is indeed the most exciting time we’ve ever witnessed for entrepreneurial software developers. Their future is so bright that sunglasses vendors are lining up outside their apartments and incubator facilities to sell them some stylin’ new shades.

Ron Wiener is a six-time serial entrepreneur and an angel investor, best known for founding Earth Class Mail. He is currently “Chief Mechanic” at Seattle incubator Venture Mechanics. Follow @

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  • http://bcviewer.com Paul Irvine

    quite right Ron, the landscape has changed again. App store has highlighted it, but its by no means the only avenue. I’m seeing 5 to 10 downloads a day for web software, with almost zero marketing. It doesnt sound like a lot, but it adds up. and now more than ever, a single developer with a decent idea, can bring a product to market with virtually no investment at all. Its a new world where VC’s are not even players. My very best to you,

    pi

  • Memphremagog

    Yes – small software teams can now create small businesses better, faster and cheaper than ever before. Some can create a nice wealth engine for themselves. But, if they want to be part of something greater and do something that creates a major enterprise, they will still need cash, executive talent, and maybe even the guidance professional some venture capitalists provide.

    It is always great sport to trash the VCs (and sometimes they really deserve it!). But it simplistic and wrong to say they don’t have a role to play in the right circumstances, or that software developers don’t need them anymore.

    As always, the issue is to match your funding source to your business and your aspirations.

  • http://www.covario.com Arnel Leyva

    Incisive and strategic analysis — you seem to have identified and explained the zeitgeist (so happy I got a chance to use that word in public) of the current Internet market. As a career product manager for small- to mid-size startups and growth companies, I like to consider myself on the side of the ‘creatives’, though it’s my job to tell them how NOT to develop products for other engineers and instead do so for the other 90% of the population. So just as in previous technology markets, the most successful apps will be developed by a two-person team comprised of a creative engineer and creative marketer who use just enough process to get a compelling product to market quickly and inexpensively — every Wozniak needs a Jobs.

  • http://www.personalmedicine.com Natalie Hodge MD FAAP

    What great perspective, Interested to learn more about your model and incubator. We have been bootstrapping and self funding for years and now that we have come into customers, complete product and revenues, the Venture route looks riskier and riskier. It’s a matter of the right money at the right time from the right people and overall decreasing the risk of the company as we move forward. The notion of a small team that continues indefinitely in lean mode, which plans to KEEP the company for the long term is very attractive to us as founders. Last months Fast Company notes many lean ” virtual businesses” which generally are in the ecommerce space, which operate out of virtual offices, with independant contractors, utilizing basecamp, web ex, and sharepoint. We are products of Steve Blank and Eric Ries customer development and lean teachings, and plan to run the company lean indefinitely as we add process and implement our customers.

    Natalie Hodge MD FAAP
    http://www.personalmedicine.com
    ” Your Doctor Comes to You”
    About Us http://bit.ly/ceWSh6

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