Fred Destin

Like many others in the field I was left scratching my head about Snapchat recently.  Not because of the reported $4 billion offer but because of the explosion of age-old arguments about how scandalous it is for a company with no revenues to be valued that highly.

I really thought we put that tedious debate to bed a while back, but I guess not.  Grown-up warnings about how real businesses have real revenues were yet again littering my twitter feed in recent weeks.  It's as if the last ten years of consumer innovation never happened.

Here's a selection:

• "why do investors think a silly app with no clear revenue model is worth so much money?" says Meghan Neal at the Verge 
• 'The approaches to Snapchat come amid rising exuberance for social media, and mobile-messaging upstarts in particular" says Evelyn Rusli of The Wall Street Journal
• "Once your valuation is in the billions, there is no room left for friends or family to bail you out – only fools if you are lucky enough" says Alex Wilhem on Techcrunch
• "Because this time, it's different. It always is, right? ;)" quips Chris Ciaccia for the Street

Be a student of recent history

Slamming zero revenue companies seems to happen every time a large, zero revenues company emerges.  

It was true at the time YouTube started out;  Google was ridiculed for the price it paid.  It was true when Facebook became successful; the lack of imagination of the pundits about the capacity of monetization for Facebook's data was stunning and the fact that the IPO was priced at a punchy level allowed these same know-it-alls to hit back with a vengeance.  "I told you so", they chanted, pointing to lackluster ad revenues and not realizing that we were just in the first innings of the juggernaut's monetization efforts.  It was true when Instagram was acquired, with heads nodding in disbelief that facebook would pay $1bn for 10 guys and an app.

A few years down the road, YouTube is clearly a phenomenal acquisition.  How would you like to be in the shoes of the company who paid under $2 billion for the world's largest media and music site ?  The 2% of dilution or so that facebook suffered on Instagram delivered them a large part of the answer to their biggest existential threat, their weakness in mobile.  Think that was worth 2%?  And please don't get me started on Twitter, long dismissed as nothing but a fad. 

Zero revenues as sound business strategy

If you're running a business that is predicated on tiny revenues per user (such as an advertising based revenue), it's common sense to realize that you need scale.  Humongous scale.  It's often entirely rational to shun revenues until you have achieved that scale.

You need scale for three reasons:

Revenue argument - if your business is a $3 CPM business, run the maths, you need a ton of users. That's pretty mechanical.

Relevancy argument - large advertisers need both scale and intent. Before you get Sprint or Ford interested in your app or site, you will need to make it onto media plans & emerge as a top media property in the segment that you are in, as well as deliver large relevant audiences to the advertiser. So there is no point in monetizing early.

Cost argument - Operationally your business gets way more efficient when you have ton of users sweating your tech platform.  If we take the case of the video sharing sites, they get MASSIVE economies of scale that are related to how much of their own traffic they can route through their own CDN.  It was the difference between life (DailyMotion) and death (Metacafe, Veoh).

Supporting yourself through the capital markets

If you want to build a sustainable business, you can take money from customers or from the capital markets (i.e. VC's).  The private markets are fairly patient, and it's perfectly acceptable to go into a VC meeting and say "we're wilfully ignoring revenues for the time being as we sustain ourselves through external capital injections".

Non linear value creation

I have sympathy with the fact that it's tough to get your head around a company moving form $100M to $1 billion in the space of months.  But before you dismiss that as crazy, consider the following : we have ample evidence that companies who achieve network effects scale at insane speed and tend to be extremely sustainable over time.  When that signal begins to emerge and a startup moves away from a crowded field and achieves escape velocity, valuations follow.  Of course these assets are extremely hard to price but the lofty valuations tend to reflect the size of the prize.  No irrationality here.

Inside a company with no revenues

I was a first round investor in DailyMotion.  We moved from 3 million to 45 million uniques a month in under 6 months, and at last count we had 200 million uniques.  We had over 60 competitors of which 5 had similar scale.  One of these competitors was called YouTube and benefited from a tight integration with a social network called MySapce.  So what did we do ?  We decided to completely de-prioritize revenues.  Scrapped it off the roadmap.   Why ?  Because it was simply not possible to survive that kind of ramp and continue to innovate on product and implement the tools of monetization at the same time.  Because we understood that if we could hold on to that #2 spot we had a business.  I cannot disclose numbers but let's just say that at last count we had well over $50M in revenues and were nicely profitable.  The strategy worked and arguably was the only strategy to success.  

Two words on snapchat

Right now the argument seems to be that only a fool would buy snapchat.  It's interesting to me that the immediate assumption when the public sees numbers they don't reconcile is that (a) we're in a bubble (b) fools must be involved.  I doubt that.

One of the biggest revenue grossing industries in the world is called mobile messaging.  The formats have not been fundamentally modified since SMS came onto the scene.  Twitter has a broadcast type follow model but it does not evolve the message itself.  Snapchat does just that in the core messaging market.

There are a ton of valid questions about sustainability of its social graph and its risk profile is certainly not for the faint of heart.  But new giants aren't build by being faint-hearted.  But don't let lack of imagination constrain your thinking.  What if Snapchat messages became permanent tomorrow, would you look at it differently ?  What if the user base sticks together but sees zero benefit to message permanence ?  Whoever said having a digital archive had to work for Snapchat because it works for Facebook ?  As for ad formats, don't tell me an exploding offer targeted at the right user group does not hold potential.

My bet is on intelligent founders and investors looking at usage and growth patterns and thinking rationally they don't want to sell out too early.  My bet is against pundits making pronouncements on the back of zero information and a sense of self righteousness and "sound business judgement".  The future does not look like the past.

Skype was probably wrong to sell when it did.  It could have reinvented telephony.  I'm not holding a crystal ball, but one of these messaging startups is going to nail telco to their cross.  I just wish I knew which one.