Monthly Archives: September 2008

Why Angels Continue to Invest in Consumer Internet Deals

Less Due Diligence is Required in Consumer Internet

I was looking through my portfolio of investments the other day and realized I have been over-investing in consumer Internet deals.  Of the many companies I have invested in over the last six months (including 750 Industries, AdRocket, GoodRec, Huddler, LabPixies, Lefora, Mechanical Zoo, Offbeat Guides, OtherInbox, Play Megaphone, SnapTalent, Yotify, and more) only three are not B2C.  Why?   I’ll try to explain.

Like many angels, I have been trying to diversify and actively trying NOT to invest in consumer Internet companies.  I run a B2B company and have an affinity for building strong technology for the enterprise.  And I have seen a lot of good enterprise software, SaaS, services, and other deals that I couldn’t pull the trigger with.  Most other angels are in the same boat.  Here’s why . . .

Consumer internet companies require a lot less due diligence than almost any other company.  And that’s important for most angel investors who generally invest as a hobby and devote less than 2% of their time to the investments (I personally spend my Saturdays talking to potential companies instead of doing other hobbies like golf).  That means angels cannot spend a lot of time evaluating a technology or a team.  They need to look at the product quickly and make a decision.  Many angels make a yes/no decision in just one meeting.  

With such little due diligence, it makes investing in enterprise software extremely difficult.  At the angel stage generally all the team has are its bios and a slide deck.   They product might still be months (and sometimes years) away.  That makes investing without doing due diligence ultra risky.

Consumer Internet is much more capital efficient (at least in the beginning).   Most angel investors in consumer Internet deals invest AFTER the product is already built (not before).  This is important because as an investor you can see if they have a good product and it can eliminate some of the technology risk.  In fact, one of the biggest problems with many start-ups is that they never actually ship.  Just shipping something good can massively increase the chance of success. 

Sometimes the product already has users who you can talk to about their experiences.  Even when a product has no users, by playing with the product you can imagine how people WILL use it.  It is much harder to do that in the enterprise without extensive interviews.

When I met the founders of Meebo three years ago it was obvious they would become a super company.   In fact, I have still never seen anything more obvious.  There were three rock-star founders (two of which are engineers).  They had no money.  But they built a product that is really HARD to make.  And they had users who absolutely loved the product.  My entire due diligence was talking to the founders for an hour, using the product, and calling a few third-party people to get references on the integrity of the founders.   The Meebo team continues to impress me today.   

That said, all this means consumer Internet companies are probably over invested in because it is much easier to invest.  A smart investor with more time should probably focus elsewhere to increase their returns.  And the schleps like me who invest only as a side hobby will likely continue in the consumer world, even if we see a downturn there.  

Birds of a Feather Shop Together

The Early Bird (Who is
Your Friend) Gets the Worm

It’s not too radical to claim that people are more like their
friends than they are like other people that fit their demographic or
psychographic makeup.  Social psychology
has shown that people tend to develop relationships with those that have
similar interests to them, transcending demographics and psychographics.  And those that have a strong relationship
with each other have the capacity to influence each others’ behavior.

Marketers traditionally have put consumers into various
buckets in order to compartmentalize and therefore easily learn and make
assumptions about them.  These marketers
lack the Holy Grail social-graphic information: friend connections and
relationship information amongst their consumers. 

 

Past – Demographic Targeting

Looking at John S., for example, he fits in the 25-34 year old, white male from San Francisco, CA bucket; now, marketers will assume that John is likely to respond to offers other people from his bucket generally respond to. In the absence of any other information about John, this demographic convention is the best they can do, with additional information obviously being more useful.

 

Present – Psychographic Targeting

When it comes to targeting people based on their
psychographics and interests, politicians, especially, have been highly successful.  If John S. subscribes to Guns & Ammo magazine, he might be very open to a message from a
pro-gun candidate despite living in an area where the vast majority of
inhabitants strongly support a ban on guns. 
This type of psychographic targeting is more successful than targeting
purely on demographics — psychographic targeting is not as broad and can be more
descriptive.  Thus, John’s interests in
one area is a good predictor of what he might buy in another area, independent
of the behavior of those within his demographic bucket

 

Future – Social-graphic Targeting

A more powerful predictor of John’s purchasing behavior is
what his friends are doing and buying.  For
instance, people interested in wine tend to hang out with people that also are interested
in wine.  And if a company is pitching a
product, its best prospects are the friends of its current consumers: a golden
leads list.

A study by Shawndra
Hill
, now Assistant Professor of
Operations and Information Management at the University of Pennsylvania, shows a very strong correlation among friends purchasing the same items. This intuitively makes sense: one cannot pick his demographic makeup, but can and does pick his own friends, often based on similarity in attitudes, values, interests, and personality. This similarity leads to similar behavior and buying patterns amongst those friends.

Implications of Social-graphic Targeting

The problem for marketers and companies is knowing who
someone is friends with since few companies have access to the social graph of
their consumers.   But companies with access
can leverage that information for better targeting.  By better targeting consumers, companies can
cut down on advertisements, spam, and harassment to consumers and create a
world with more relevance, consumer happiness, and better use of everyone's time. 

Companies with this information include telecom providers,
social networks, webmail and IM clients, and search aggregators.  As one’s social graph becomes a commoditized way
to do better targeting, these companies (and others) will become increasingly
valuable.

Telecom providers have great social graph data.  They know who often calls each other – an
accurate representation of one’s social graph. 
These companies can do analysis on this data and even determine type of
relationships based on the frequency, duration, and timing of calls (e.g. most
people tend to call their mom on Mother’s Day).  

Similarly, free webmail clients (Gmail, Hotmail) and IM chat
clients (AIM, Yahoo) have a gigantic social graph of everyone that communicates
with each other.  In the future, this
social graph data can be used to change the way these webmail and IM clients
display ads based on the behavior and activity of one’s social graph.

Online social networks have a good idea of who people know
and the extent of their relationships. 
They could partner with retailers to better pitch products based on what
peoples’ friends are doing.  Facebook
already does this with Social Ads (and is what they attempted to do with
Beacon).

Search aggregators, such as Google and Rapleaf [disclosure:
I am an employee of Rapleaf], aggregate public connections data from thousands
of blogs, forums, social networks, discussion boards, and more.  These aggregators can enable marketers to
better understand their consumers and provide a more customized experience and
product recommendations based on the consumers’ friends’ interests and buying
behavior.  Companies that really want to
better serve their consumers with a more customized experience, can leverage
these friend maps effectively.

It turns out that the obvious is true: birds of a feather
really do shop together.