Capital efficiency is a hot topic for Web entrepreneurs these days. I've outlined a lot of the reasons we've gotten here in prior blog posts... it's a combination of a bad economy, a maturing yet healthy & evolving Web business from search to social media, the fallout of Sarbanes-Oxley and the resulting lack of IPO activity, a weak M&A market, and poor venture capital performance over the last decade.
Time marches on and despite the broader macroeconomic climate, entrepreneurs continue to innovate. I think it's an important distinction to keep in mind at all times -- entrepreneurship and innovation are (relatively speaking) a constant. The economy, investment activity, and valuations are comparatively not.
After living through a few of these cycles now, I'm beginning to think that our business follows three distinct and separate timelines that together create the environment for entrepreneurs.
Platform Development -- major tech players create/invent new platforms that promise tremendous benefits for businesses and/or customers. Examples: Windows (ca. 1994), Web (1996), Google/Search (1999), Facebook (2006), iPhone (2007), Twitter (2008).
Innovation via Applications -- entrepreneurs build products (mostly old ideas) on new platforms because of the advantages the new platforms provide. This is an experimental phase that begins with a lot of ideas and not a lot of proof, so valuations are relatively low but entrepreneurs and investors are optimistic.
Hype/Mainstreaming -- after a few applications succeed & begin to unlock the value of each new platform, the hype machine kicks into high gear. Valuations go up because people have discovered ways to make significant money from the new platforms.
For my money, we're in a fairly mature phase in platform development. People have optimism today about Web entrepreneurship because quite frankly, not a lot happened post-Google. Now entrepreneurs can target social media or the iPhone as two major platforms currently in their early years. We've already seen a few success stories with these platforms -- Zynga being one of the most prominent -- but there will be more.
We're starting to see a wealth of new applications come about to take advantage of social media as consumers and corporations deal with the shift from search to social. These applications come in a variety of forms -- some are games that you can play with your friends, others codify the time consuming process of monitoring, measuring, and succeeding with social media, others are innovations in existing businesses with the overlay of social and/or mobile context.
As people succeed with new ways of doing business, the hype machine will kick into force. I am not sure we'll see ridiculous valuations again like we did in the late 1990s, but we will see more companies and products come to market. The difference between now and the 1990s is that we've seen what a bursting bubble can do -- so everyone is a lot smarter and more rational. Successful businesses will be built not out of hype, but out of free cash flow. The ones based largely on hype that emerge late in the game will again be the ones to fail.
So in closing, capital efficiency is all about building a business the old-fashioned way -- one profitable customer at a time and on a shoestring. If all the hype is indeed about capital efficient businesses, we won't see a big bursting bubble but rather healthy businesses that can live and prosper for a long time. We're all better for it.
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