Traction is the new IP

By boris, October 18, 2012

“Traction is the new IP” sums up perfectly how the technology space has evolved over the past decade due to the nature of the web. Barriers to entry are no longer created by patents or by tech differentiation alone, but by superior traction in the marketplace.

In today’s web landscape, word of mouth drives adoption and can lead to “winner takes all” (or almost all) in both B2C and B2B markets. Category leaders do very well, while the #2, 3, 4… players struggle to attract customers and financing.

This trend is particularly true in markets that are highly susceptible to network effects, such as online auctions and social networks. In these markets, we often see one major company emerge and take all of the value created in its respective category.

Even beyond auctions and social networks, the web tends to prefer the category leader. This is true in most SaaS categories, including enterprise applications. Consumerization of IT has accelerated the pace of software adoption in the enterprise, placing greater significance on market traction and momentum.

In the past, the adoption of an enterprise tool was primarily driven by the quality and aggressiveness of a sales force to win over more customers. The pace of adoption was kept in check by the limited size of the vendor sales force, as well as by gatekeepers (CIO/IT department) on the customer side.

However, now individual employees get the ball rolling by using a product. If that product proves useful, adoption ripples between colleagues, departments, and companies, without any discussions between a sales rep and IT department. Again, word of mouth can lead to a strong market leader, creating a significant barrier to entry for anyone else.

Know your market dynamics

If traction relative to your competitors defines the success of a company, it’s absolutely critical for any entrepreneur to understand the dynamics happening in his or her market. It’s also important to realize how little value investors therefore put on IP when investing in a company.

The same logic holds true for most acquiring companies. Let’s take my own portfolio as an example. To my knowledge, only 4 out of my 35 portfolio companies have filed for patents. Three of those have since been acquired and patents did not play a significant role in the acquisition process.

So, in this new market dynamic, should you go for patents?

If traction is the new IP, the question still remains if your startup should file a patent if you see an opportunity. Here are a few things to consider:

  • Treat a patent only as optional value: It can take up to 10 years to get your patent granted. Most startups have either been acquired by then or are in the deadpool.
  • Most investors and potential acquirers will not separately value patents unless they are granted (which again, can take up to 10 years).
  • If you want to file a patent and have limited financial resources, consider filing a provisional patent. This is a lower-cost first patent filing that at least gets the process going and gives you a year to test your idea before filing a full patent application.
  • Limit the exposure you give patent opportunities in your investor pitch – it sends the signal that you might be focusing on the wrong priorities.
Enhanced by Zemanta
  • http://www.onceabeekeeper.com/ Kevin Swan

    Agree. While patents were traditional offense moves for web companies they are purely defensive moves. In other words, don’t worry about it unless you have something to protect – mainly significant traction.

  • sigmaalgebra

    For a VC, this thinking is badly wrong. Yes, the remarks about “trend” and “tend” are correct, but they are also invitations to VC disaster. In simple terms, VCs can’t make money with “tend” and “trend” and, instead, need what is quite exceptional, fewer than 1 in 1000 of what Sand Hill Road funds. The remark about the importance of being a “market leader” is similarly dangerous and would imply that Univac would never be beaten by IBM, IBM would never be beaten by Intel, Microsoft, Cisco, Seagate, EMC, Gateway, Dell, and HP, that Apple would never rise to challenge Microsoft, that Samsung and Android would never challenge Apple, and that Facebook would be the last company doing well with social networking so that there would be no InstaGram. Nonsense.

    Your ” tech differentiation” is similarly dangerous: Just what examples do you have in mind? Or, by “tech” what do you mean, just some routine software that needs only a BS in computer science or just self-taught programming, or do you have in mind something new, significant, powerful, difficult to duplicate or equal, and with valuable results?

    The core problem is, as a VC, you are necessarily looking for the very rare and exceptional, and here “trend” and “tend” are at best irrelevant and otherwise a dangerous delusion. Instead of “trend” and “tend’, you need to look for much more powerful means of evaluating projects for value and for how such projects can be created.

    To be more clear, you are looking for one out of a few successes each 10 years, and looking back over, say, 20-30 years, each month the “trend” that month was useless as a predictor of value. There actually are some good predictors of high value, but they are not “tend” and “trend”.

    I’ll give you an auto analogy: If you want to build the world’s best car, then you don’t just go to a shopping center parking lot and pick your favorite. Instead you get some good engineers and a lot of clean sheets of paper and design that car. What’s important is that design work and not “tend” or “trend”. Understand now?

  • http://twitter.com/bwertz Boris Wertz

    I get your point but don’t understand what it has to do with the post – the post focused on explaining what dynamics are at play in “winner takes it all” or “winner takes almost all” markets and didn’t focus on describing what successful investments or VC strategies are.

  • sigmaalgebra

    Since you are from Munich, when my startup needs to expand to Europe, then I’ll be sure to go to Munich for Oktoberfest and also Bayreuth and King Ludwig’s place and then come home with an AMG of some kind!

    But my German is at best ‘rusty': ‘Schon vergessen oder nie gelernt.’

    > I get your point but don’t understand what it has to do with the post – the post focused on explaining what dynamics are at play in “winner takes it all” or “winner takes almost all” markets and didn’t focus on describing what successful investments or VC strategies are.

    Since you are a VC and wrote, e.g.,

    > It’s also important to realize how little value investors therefore put on IP when investing in a company.

    I assumed that the ‘focus’ of the post was predicting company success for both entrepreneurs and investors (VCs).

    It’s a common problem in writing: Lay out some material and then have people use it for a variety of purposes!

    But for

    > what dynamics are at play in “winner takes it all” or “winner takes almost all” markets

    some of what I wrote indicates that there are no clear broad, general answers here. Instead, we would need to consider cases one by one.

    Of course, similar to “winner take all”, there is the idea of a ‘natural monopoly’. A classic example was supposed to be AT&T — each customer in doubt used AT&T anyway because nearly everyone else they would want to call also used AT&T. Alas AT&T went essentially bust and was then bought up just for the brand name.

    So, maybe FedEx should be a natural monopoly — each customer in doubt uses FedEx anyway because FedEx serves the most destinations. Alas, as FedEx COB Fred Smith might explain, the situation is not that simple, and FedEx has various competitors for various reasons.

    Maybe romantic matchmaking should also be a ‘natural monopoly': Each lonely heart in doubt joins the biggest service because they have the most lonely hearts to match with. Alas, in fact there is more than one romantic matchmaking service.

    But, maybe, just maybe, in a single city or county, there should be mostly just one — that is, romantic matchmaking should have a ‘geographically local’ natural monopoly. So, a good service X in some one city A might do well against some nationwide service Y that has many more members because service X might actually have more members in city A. That is, that service Y can match someone in city A with someone 1000 miles away is not very ‘romantic’. So, one city at a time, service Y can be attacked.

    But even just in city A service X might be vulnerable to attack. How? Sure, pick a certain religious group where the people in that group want to meet essentially only other people in that group and work hard to get the most members in that group in city A. Then expand to another religious group in city A. Then expand to city B. Etc.

    On the Internet, maybe Disqus is on the way to being a natural monopoly: All the blogs use Disqus because all the visitors are Disqus members, and all the visitors are Disqus members because all the blogs use Disqus. I suspect that Fred Wilson thought of that.

    Sure, a good mall shopping center can be a natural monopoly: All the good stores are there because all the good customers are there, and all the good customers are there because all the good stores are there, and the mall owner is neither a customer nor a vendor but gets to keep raising rents! Nice dream: Alas, a nicer mall might open just next door and take all the good stores and customers and leave the first mall with poor customers, junky stores, dirty floors, low rents, and a mortgage underwater!

    In PC software, be Microsoft: All the applications are for Windows because all the desktops run Windows, and all the desktops run Windows because all the applications are for Windows. Alas, smart phone and Internet applications are seriously hurting Windows desktop applications. Reasons include (1) each Windows application running is a potential security risk and (2) applications installed on user desktops are a pain in the backside for both sales and support.

    In ‘internet technology’ for the Internet, for a Web site there can be a ‘network effect’ where having more users makes the site more valuable for each user. So, maybe Hacker News is like that: That Hacker News has so many readers/posters means that the competition for good ‘karma’ and space on the first few pages is high meaning that the quality is higher for each reader. Alas, now a concern about Hacker News is that it is too big and, thus, not well enough ‘focused’.

    One piece of support for “winner takes all” is a little equation: Consider, say, a Web site. Denote time by t, and let y(t) be the usage of the site at time t. Let b be the long term maximum usage. Suppose that at time t, the rate of growth in usage is proportional to the number of current users y(t) talking about the site but also proportional to the number of potential users not yet users listening to the talking b – y(t).

    Of course, the rate of growth is the calculus first derivative of y(t) with respect to t, that is, y'(t) = d/dt y(t).

    So we have the first order ordinary differential equation initial value problem, for some constant of proportionality k,

    y'(t) = k y(t) (b – y(t)

    Assuming that the present is t = 0 and we have the value of y(0), then we can solve for y(t). I will leave the solution as an exercise in first calculus for the reader! But a graph looks like a ‘lazy S’ curve that rises, rises more quickly, rises more slowly, and approaches b asymptotically from below. Roughly the curve matches, say, the growth of B/W TV sets, etc. There are some people at FedEx and General Dynamics who can tell you the role played by this equation at FedEx!

    So, here we have an equation for the effects of customers talking to potential customers, that is, viral growth. So, viral growth starts to look more real and where we know more about it.

    Still, traction, viral growth, natural monopoly, winner take all, etc. do not impress me as replacing intellectual property or anything else important for the project planning of entrepreneurs or the evaluations of investors. Or, in a car analogy again, what’s just crucial is picking a good niche in the car market and then designing and building a great car for that niche. If do that, then traction, viral growth, winner take all, etc. will ‘take care of themselves’, will be consequences but not strong causes.

    But just now I got some software for Web site session state storage written and ready to run inside my Web pages and need to get the Web pages using that software and the session state store! If it all works, then I’ll make that trip to Munich, also go to Paris for orange duck, the Italian Piedmont for some beef and Barolo, and Vienna for dessert!

  • http://twitter.com/bwertz Boris Wertz

    All good points but just for the record – I don’t think that a “winner takes it all” concept explains everything (and there are many other elements at play to define start-up success) and secondly, I am based in Vancouver and not Munich :-)

  • EQ FTW

    Wow,
    Apparently insulting people on their own blog is the new way of showing you are smrt.

    sigmaalgebra, I’ll admit that you have proven (at least to me) that you are very rare and in some odd sense exceptional. As you know what thinking is right and wrong, would I be correct in assuming you are highly successful already (given your insight on VC practice, possibly even an experienced VC turned LP looking to place funds?), and are just building the startup you mentioned on the side for fun?

    Just in case you’re not and your acumen hasn’t come from successfully building businesses and you aren’t independently wealthy from all your exits yet, and primarily for the benefit of other readers, who might be wondering about the wisdom of proving they are rare in the same manner, I would offer the following tip on getting funded: Most VCs I’ve encountered invest in people who have social skills.

    Theres an interesting question that has come to mind while reading your posts though, and I am genuinely intreigued: Are there any VCs or angels out there who invest in people they find offensive? Has publicly opening with insults towards a well respected member of the startup investment community ever worked for an entrepreneur? (I am seriously interested, maybe it’s a fresh new approach, just the kind of trend bucking that could get me funded and make VCs money…)

    On the bright side Boris, he will likely go to your office in Munich when its time to pitch.

    Ps. Its just a personal perspective, but sometimes there are answers beyond what you know to be true in math. Find x :)

    EQ FTW!

  • sigmaalgebra

    Startup planning is important stuff. Apparently your concern was my

    > Apparently simplistic, brain-dead nonsense is the new thinking.

    In case you haven’t noticed, (1) the thinking in this post was a bit “simplistic” and, thus, was “brain-dead” in the sense that it trivialized and, thus, didn’t take seriously the serious issue of startup planning and (2) it is common for VCs to have blogs and toss out simplistic remarks, apparently including to entrepreneurs, on startups.

    Well, I’m an entrepreneur and rightfully resent people, including especially VCs, trivializing the work I have to do in startup planning. So, I responded with some resentment, rightfully so, and then took startup planning more seriously.

    Your source of resentment seems to be just anyone contributing some rational discussion. What really got to you, the little differential equation? Such is not courteous or politically correct in your circles?

    In particular, by taking serious issue with the role of “tend” and “trend”, I was making an important point about a nearly ubiquitous error in much of the startup community and VCs: Net, due to the crucial role of the exceptional, “tend” and “trend” are nearly irrelevant for both successful entrepreneurs and their VCs. VCs can make that error if they want, and I can believe that their LPs encourage it, but they won’t get it from me.

    If my project works initially, then it will need more technical work that will have to be planned, executed, and successful. The BoD will likely want to review and maybe even approve the planning and will, then, want reports on the execution and success. Okay. But for good success, I will want some good planning, and for that I mostly will not be using “tend” and “trend” but ‘other means’. Then, a VC on my BoD who thinks in terms of “tend” and “trend” would terrify me. Thus I wouldn’t want their check or them on my Bod to begin with.

    More generally, on all your delicate Victorian garden party social graces, as a good omelet requires breaking some eggs, a successful entrepreneur needs to follow some thinking where being exceptional is necessary (although not sufficient) and not fall for something simplistic that is not good even if it is politically correct. Thus, a good VC, e.g., read some Fred Wilson, will realize that a good founding CEO is not necessarily the most popular guest at a Victorian garden party.

    The main issue about what I wrote is, is the thinking correct or not? You didn’t address that. Instead, as is common in poor blog posts, you attacked the person instead of the ideas.

    For my ‘success’, I’ve had a lot in various fields but now am pursuing financial success. E.g., that little differential equation was mine and at one point got the FedEx BoD members from General Dynamics to unpack their bags, cancel their plane reservations back to Texas, and stay after all. All the FedEx top management, except Mike Basch who was traveling that Saturday, was there and likely remembers — ask them if you wish. So, net, with that differential equation, I saved FedEx. Is that a “success”? That was the second time I saved FedEx by pleasing the BoD: The other time was written up in a peer-reviewed publication (by others).

    Always necessarily I am pursuing what I have not yet achieved so, contrary to your suggestions, that I have some successes yet to achieve does not mean failure.

    If you do not value the effort of planning for success and value only success and only after the fact, then the lottery winners are your heroes!

    Also in response to your suggestion, there is no way I would be applying to Boris for equity funding: First, his interest in “tend” and “trend” are close to disqualifications for me. Second, since I am in the US, I should not be take equity funding from either Germany or Canada.

    My real purpose here was to push back against poor, simplistic thinking in the VC and LP communities. So, this push back is broadly aimed, and not nearly just at Boris; considering that only a small fraction of VC firms have good ROI over the past 10 years, at least some broad push back has to be justified. I want nothing to do with such ROI, and it is appropriate to make that point so that it can be heard.

  • Victor Hou

    Great post Boris……..although when you look at a big company like Apple, they got a lot of patents when they first started the first iphones and ipods and because of their innovation and forward thinking they are reaping that benefit today by taking everyone else to court. But for startups I agree with you, filing patents are very expensive and takes a long time to get approved, so while you are waiting there for 1-2 years if your idea haven’t taken off or someone else did the same thing and took off, it’s too late for you.

    We at TrendStartr thought about filing for a patent because we had created a way for users to filter their social networks to only what you want to see based on location, topics, and people, to help people filter through all the mass content they see everyday.

    I want to take the time to respond to the article because I believe in your vision and topic of “traction is the new IP” I don’t think there’s a right answer for this as filing patents “may” protect you and benefit some startups in the future.

    TrendStartr launched few weeks ago and already tripling in traffic each week globally and we have really enjoyed your articles and thoughts, we look forward to continue learning from you and hopefully get a chance to talk one day soon

    Victor