Boxed In

Caged Wild Man by gillfoto, on Flickr
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The oft-repeated explanation for Box’s failure to IPO is that they somehow filed at a bad time and “missed the window”.

As usual with Box, the sound bites are better than the substance. They filed on March 24th of this year, a year that has seen the most IPOs since 2000. Since Box’s filing date there have been over 40 technology IPOs (with at least one in every month). These have included various software, SaaS and subscription companies like Hubspot, Yodlee and ZenDesk as well as HortonWorks and New Relic this week. What window exactly is closed?

Meanwhile, the stock market is not far off all-time highs, even as oil plunges, China slows, Russia invades and retrogrades, the Middle East burns, Europe self-immolates, and Ebola spreads, so it isn’t a macro problem.

The “Wall Street just doesn’t get it” argument is that because Box is a subscription business, they should get a free pass for their huge losses, because “lifetime customer value” means it will all turn out fine in the long run (this is of course counter to the Keynesian orthodoxy that in the long run we are all dead).

The people who generously have taken the time to educate us all on this topic (who coincidently often happen to be investors in Box) never seem to want to use Box’s own numbers to illustrate the virtues of a subscription business. Instead, they walk us through companies like Workday and imply that Box is somehow comparable in its subscription economics. They’re not.

There are good subscription businesses and bad subscription businesses. The spreadsheet-wielding denizens of Wall Street, despite their innumerable flaws, understand this quite well. They’ve been running the numbers on Salesforce, Workday and others for years, as well as subscription businesses in other industries.

High customer acquisition costs (traditional top-down enterprise sales model) combined with low revenue per customer (commodity file storage) doesn’t make for a good business. Add seemingly moderate churn and it can get ugly. There are some really crummy subscription businesses out there (TiVo and Vonage come to mind though it has been a while since I looked at their financials).

Add the very real cost of goods sold for petabytes of storage and the overhead of a freemium model (90% of Box customers don’t pay), and it gets even worse (I’ve wallowed in the storage economics and it can be ugly). To own Box stock, you have to believe they will retain their customers for a really long time to pay back the acquisition costs and/or significantly increase their revenue per customer. It is hard to make this case and Box notably doesn’t make much of an effort.

How will Box extract significantly more revenue per customer? They have neither moat nor unique technology (unless you count their “which one of these things isn’t like the others” participation in the Linux Foundation’s Dronecode Project). They don’t have an operations at scale cost advantage. Their “platform ecosystem” is superficial at best. They face giant competitors like Apple, Google and Microsoft with untold billions in the bank who are happily giving cloud-based storage away as a complement to their other services, as well as Dropbox which continues to ooze into the enterprise with a bottoms-up strategy which has dramatically lower customer acquisition costs. Box is still doing the same thing it always has, even as the market has evolved. They no longer have the luxury of just highlighting SharePoint’s inadequacies. Some argue Microsoft’s refusal to support Android and iOS has been the singular Box value proposition – obviously, that is a window that has closed.

The implicit financial bet/hope is Box will find a new and better business soon. But if you read the S-1, you discover Box doesn’t really know who they are or where they are going (though they do claim they’ll be really agile getting there). They’re happy to make a few jokes and compare themselves to all of Apple, Facebook, Zappos and Salesforce with a straight face, yet can’t describe their own raison d’etre (beyond giving good soundbite which I yield to no one in my respect for but tragically that competence is not a foundation for spending hundreds of millions of dollars a year):

We design our software with the passion and attention to detail that you’d expect from leading consumer companies like Apple. Similar to Facebook, we release updates to our product continuously, which allows us to act on user feedback to improve the Box experience and respond to opportunities with agility. We support our customers with the greatest care and attention, delivering Zappos-like support. And we’ve created an open ecosystem much like salesforce.com [sic], leveraging the talents and skills of tens of thousands of developers outside of our corporation to build value on Box.

What would it mean for someone to describe their company as “like Box” in a positive way?

Which brings us to their updated S-1. The good news is Box has reduced their burn, but with it their growth. Box has been a poster child for the recent “excessive burn rate” startup critique. But this is not entirely fair, as Box’s massive spending is not sumptuous employee benefits or other discretionary items, but rather is baked into the business model for customer acquisition.

Then there are the details of the Series F (as in “F#&ked”) financing Box raised this summer when it became clear an IPO was not in the cards while they were still burning mountains of cash. The private equity investors dictated stark terms and will get “theirs” well before any other investor.

Given the Series F investor preferences ratchet up even further if Box doesn’t IPO by July 7, expect an all-out push to get this turkey over the finish line. Amid that push to ring the bell, I hope Box’s fans will explain to us how the company will become a viable and even decent business in the future as opposed to just chanting “LTV FTW” because they really want to get it out of their portfolios. Customers and investors beware.

Segmenting Virtual Reality

The Lawnmower Man (aging VR star)

When you say virtual reality today, most people think of Oculus VR. They singlehandedly resuscitated the ‘90s flash-in-the-pan that was virtual reality (with no small help from Moore’s Law). But the space is developing quickly and there are multiple segments emerging with very different capabilities, price points and challenges:

  • PC VR – the Oculus Rift DK2 headset famously utilizes mobile display technology but still relies on a PC to do the processing. The fact is it requires a very beefy, high-end PC to deliver the buttery smooth frame rates so important for great VR experiences. So while the headset is only $350, in practice you’re looking at out-of-pocket cost of over $2,000 unless you’ve bought a high-end gaming machine very recently. The Rift actually drove my first new desktop PC purchase in over five years (take note Intel and Microsoft). Ironically, even the latest generation game consoles may not have enough oomph to be competitive with PC-based VR, which explains Sony’s ambivalence around their Project Morpheus VR headset.
  • Smartphone VR – meanwhile the immense volumes of smartphone have driven rapid advances in CPUs and GPUs in addition to displays. The latest smartphones are very capable on the graphics front, though still materially behind PC GPUs (smartphones simply can’t consume the same kind of power). And as is typical of all things smartphone, there is a strong urge to get the PC out of the equation altogether. Google kicked things off with Cardboard. Even with Google Glass going the way of being “Segway for your face” (i.e. the uses are more mundane and commercial than consumer), they could not resist taking a shot at rival Facebook who had recently purchased Oculus for $2 billion. This cheap cardboard kit let you somewhat awkwardly affix an Android smartphone to your face. Suddenly overcoming their previous disdain for mobile VR, Oculus responded by partnering with Samsung (or perhaps found their display supply taken hostage until they agreed to partner) for what became Samsung’s Gear VR, a $199 headset to which you add a Samsung Galaxy Note 4 phablet. Unlike other Samsung spec-driven sprints to be first to market without pausing to entertain so much as a single use case, the Gear VR is actually a surprisingly good product (no doubt due to Oculus’ deep involvement, which also means this is another class of device where Samsung is relying on someone else for the software). It eliminates the wired tether of the PC-based headset but is inferior to the Rift in performance as well as a number of functional dimensions (e.g. no positional head tracking). The big problem is it requires a new (and probably unsubsidized) phone, so it still has close to a four figure price tag. But why require a new and specific model of phone at all? Why not let people use their existing, recent model smartphones (say iPhone 5 and up as well as comparable Android phones, which quickly gets you to hundreds of millions of devices)? I invested in MergeVR which does exactly this, getting the price of smartphone VR down to $99 for a headset and controller that work with your existing phone. The test of this whole category is whether you can you run a “good enough” experience on a smartphone. Because of both the Gear’s 2014 ship date as well as Samsung handing out cash to developers, the center of gravity for VR software development has shifted to the smartphone.
  • Venue VR – while smartphone-based VR solutions are driving down the price by sacrificing quality of experience, there is another trajectory moving up-market to offer the most immersive experience possible. It turns out there are all kinds of industrial applications using vestiges of ‘90s VR technology that are ripe for upgrades. These venue-based experiences tend to use the Oculus headset as well as full motion capture systems (think a dedicated room full of Kinect-like sensors) that track all your movements. With no tether, they allow complete freedom of movement, unlike the headset-only solutions which while immersive for your field of view, suffer from an “arms and legs” problem (it is like you’re sticking your head through a hole into another world while the rest of your body remains awkwardly seated). The team at AtomicVR has built an incredible venue-based system that is far and away the most immersive virtual reality I’ve experienced. The freedom of motion is amazing. You put on the headset and you’re transported into another world (beware: there are drones out to get you…). These venue-based solutions have a wide range of entertainment, commercial and industrial applications and will sell for upwards of hundreds of thousands of dollars.

I am amazed at how fast this market is moving. Oculus, the uncontested leader in VR just a few months ago, backed by billions of Facebook’s dollars, is already in a bit of a strategic quandary. They have acknowledged PC-based headsets are too expensive for a high volume consumer product, while reversing their earlier antipathy to mobile-based VR. The Gear VR partnership with Samsung halves the cost but still requires a phone that very, very few people have (or will have). After years of selling the dream of the “consumer Rift”, Oculus has gotten very vague about when if ever we will see that oft-promised device. I suspect they are seriously contemplating an OEM business model whereby they license their technology to any and every interested manufacturer on the planet as opposed to building their own devices. The division of labor and branding around the Gear VR certainly supports this theory. Oculus has incredible talent and has set an extremely high quality bar for themselves as well as their competitors (they don’t want inferior products ruining the category for everyone). The risk is “good enough” smartphone VR trumps Oculus’ perfectionism.

Thanks to Nat Brown, Mike Lenzi and Franklin Lyons for reviewing a draft of this post.

A Dispatch from Cloud City

A few end of the year observations from Cloud City (aka Seattle):

Cloud Infrastructure

  • AWS remains a beast. Yet a chink in their armor is emerging…
  • Azure has become the clear challenger to AWS. The much maligned Mr. Ballmer is not getting credit for Microsoft’s embrace and execution on cloud. Unlike most of its cohorts rooted (mired?) in previous generations of technology, Microsoft is well on its way to making the cloud transition.
  • Despite very strong technology and an impressive operational footprint, Google Cloud Platform is still a hobby for Google. They are as yet unwilling to make the necessary non-technology investments to really compete to win here.
  • Private infrastructure clouds just aren’t happening – instead enterprises are both getting more comfortable (surrendering?) with public cloud and continuing to invest in virtualization (VMware obituaries were definitely premature).
  • OpenStack’s identity crisis is warranted. Without a credible ecosystem of OpenStack-based public cloud providers and little enterprise private cloud adoption, the OpenStack bandwagon is left providing ingredient technology to the industry itself, which doesn’t really need what the vendors are selling.
  • Rackspace’s OpenStack bet outcome is increasingly clear: they may not exit 2014 as an independent entity. They should have invested up the stack in higher value services like Amazon, not down (and to add insult to injury, I’ll wager their VMware business still is bigger than their OpenStack business). They’ve lost over half of their market cap this year. While they still sport a premium multiple, the overall trend is towards a SoftLayer kind of valuation which could put them in play for acquisition by the kind of legacy vendors who confuse hosting with cloud (isn’t HP out telling the world their balance sheet has finally recovered from Autonomy?).

Cloud Platform

  • PaaS is still a zero billion dollar category, but could PaaS end up being the level at which enterprises implement private cloud? I see more traction for PaaS than IaaS in the enterprise.

Big Data

  • In the absence of a strong set of customer successes, I think Hadoop may be spending some time in the trough of disillusionment. The challenge is not filling the data lake, the challenge is extracting meaningful and material business results from the lake. It is a data science problem far more than an infrastructure problem. How long will it take to transition to a Hadoop 2 that is robust, deployable, performance, has ecosystem support, etc.?
  • I continue to be amused that Google is so far ahead when it comes to big data that it is a material disadvantage for them. They get dismissed as proprietary while the rest of the industry is enraptured with Google’s technology from two generations back that has been awkwardly laundered through Yahoo.

What else is happening below the clouds on the ground?

The Hole in Android and Google’s Double Pony Problem

Android is on fire and Gartner predicts it will be the number two mobile operating system worldwide this year, surpassing Apple and RIMM, but behind the seemingly immortal Symbian.  Google embraced the ubiquity strategy and it is working.  But they’re getting a free pass on whether it makes money on the assumption that Android handset volume will eventually drive material search queries, advertising revenue and pull other attached services.  Unfortunately, there is a big hole in that Android business strategy, shaped roughly like this:China

Google’s self-immolation of its China presence means they won’t see much mobile (or any) search revenue in China, the world’s largest mobile market (and home to the largest number of Internet users).  Google’s mobile search share in China dropped by 30% in the second quarter and they’ve already fallen to third place (bonus points: who is second?).  Android stalwart Motorola is using Baidu and Bing on its phones in China plus there are a variety of efforts by Chinese operators and handset vendors that fork Android.  Forking sidesteps the remaining Android constraints altogether and of course provides complete discretion for what services are integrated.  So you can cut Android’s expected revenue per unit by roughly 20% just based on China.

And where China goes, others may follow in decoupling Android from Google search.  In countries with strong domestic search engines like Russia and South Korea, it may be a simple matter of consumer preference.  The more dirigisme (I’ll just note it is a French word) may not be able to resist the opportunity to play with search defaults.  And in the US, Microsoft is persuading Verizon to use Bing for Android phones with what looks like just cash.  There is a real risk of further decoupling of Google search from Android.

Now Google may be content with not monetizing Android due to its other strategic benefits.  Android pressures Apple and Microsoft, significantly disrupts the traditional operating system business model (which we may soon see extended to tablets and netbooks, which will be really interesting to watch) and raises the capabilities bar for the mobile web.  But settling for non-monetary strategic benefits when the guys you’re outselling are making billions is a little embarrassing (admittedly they’re making it from hardware).  I know Google is monetizing Android on the sly around the edges (it turns out Android is not so open and free if you want the latest version and the Skyhook lawsuit suggests some other tying shenanigans) but it is a rounding error from the standpoint of a $25 billion company.

Google is stuck between two Pony problems.  The One Trick Pony problem and their need to find another material revenue stream beyond search looks more pressing as both their search share and their revenue growth flatten out.  Their heyday window to make hay by building additional businesses while on top of the world seems to be coming to a close (life at the top is getting shorter and shorter – we’ll see how long Facebook lasts in that position.  They could peak even before they become a $10 billion revenue company.  Deferring the IPO for as long as possible makes a lot of sense for them to maximize their window).  Android is one of Google’s better candidates for a revenue stream with lots of zeroes after it, but we are already seeing multiple examples where Google’s revenue link to Android is being severed.  This could be described as the My Little Pony problem (a Sun Microsystems reference for those too lazy to click through and parse the obscure video), wherein your free software doesn’t drive significant revenue directly or indirectly, even as others go to the bank on top of your efforts.  As Google’s core business matures, they’ll have less and less ability to make grand philanthropic efforts.  I suspect we’ll see free become less free and Google dare phone manufacturers to shift platforms once they have started down the Android path.

The good news is neither of these problems are mine to solve.

Senator Blowhard – Still At It

image It takes an exceptional act of shamelessness to rise above the general level of shamelessness in Washington DC and merit comment, but noted antennae expert and Senate Finance Committee member Charles Schumer’s decision to weigh in on iPhone 4 reception issues breaks through the noise.  Clearly this takes precedence over less pressing issues like cleaning up the multi-hundred billion dollar and growing double black hole of Fannie Mae and Freddie Mac.  I for one look forward to Senate hearings on the matter.  No doubt a several thousand page “antennae reform and signal stimulus” bill will follow.

Not to endorse Senator Shakedown’s grandstanding, but I do think Apple’s reality distortion field has worn off and everyone knows it except Apple.  Dave Winer nails it.  Companies are always the last to internalize they’re not the plucky little upstart any more and public expectations have changed.

Our runner-up in inanity emanating today is the New York Times’ apparently un-ironic call for the government to manage Google’s search algorithm.  Fortunately, this has been comprehensively addressed by Danny Sullivan.

Must Have Software: Google Analytics Opt-Out

Google Analytics can track individual Internet users across millions and millions of web sites.  Google has quietly rolled out a browser add-on for Chrome, Firefox, Internet Explorer and Safari that prevents information about an individual web site visit from being sent to Google.  Presumably this was done in response to regulatory scrutiny somewhere in the world as Google does not lightly deprive itself of any information about your Internet activity.

A good start but we still need:

  • The add-on to be distributed through the various browsers’ integrated add-on catalogs and not just buried on the Google site.
  • Google needs to provide the add-on for other browsers as well.  At minimum, they need to support all the browsers they put on stage for marketing purposes (e.g. Opera)
  • Google should build it into Chrome and turn it on by default (note that Chrome still has a bunch of other privacy issues)
  • We need a similar add-on for opting out of AdSense which has a comparable tracking ability.

Notes from the Super Heavyweight Bout

Google v. Microsoft

A few observations on the super heavyweight, no-holds-barred, ultimate cage match between Google and Microsoft.  Some of these have been rattling around in my head for a while so please excuse my inability to embrace the real-time “what are you thinking (or eating) this instant” Twitter aesthetic.

Google’s Soft Landing

Google’s Q4 and Q1 performance was brilliant.  Amidst an imploding economy, they managed to ramp revenue and cut costs.  They increased monetization (let no screen space go without an ad…), slashed capex, deferred datacenter build-outs, slowed headcount growth to almost nothing, trimmed employee perks (while repricing options) and whacked a bunch of services that were going nowhere (all but killing the 20% time myth in the process).

There was always a question about Google’s management chops and how they would perform when push came to shove.  The question appears to have been answered and the new CFO seems to be getting most of the credit.

Microsoft spent the better part of a decade on its odyssey from shrimp to weenies, slowly squeezing costs as growth slowed, and still had a lot to clean up after the dot com implosion.  Doing this kind of deceleration in less than a year is very impressive.  While the claim that search advertising is immune from macroeconomics has been put to a rest, Google will outperform amidst the ongoing (and likely protracted) “global economic crisis”.

Microsoft Windows Live MSN Kumo Yahoo Search

While Google shows it has knobs that do in fact go beyond 10, Microsoft continues to play rope-a-dope in search, with an ever diminishing quantity of rope.  (Microsoft watchers should understand that When We Were Kings is a SteveB favorite).

Despite new management at Yahoo, the company still seems infected with Paralysis Yahoois, so the inevitable combination of Microsoft and Yahoo search drags on and on.

Hopefully Microsoft has more in the cupboard here than just a new name.

Windows 7

I have only played with the public beta, but it looks very good.  It even runs nicely on my much-despised Sony laptop, which was unusable with Sony’s craplets and Vista. 

And it should be good, given three years to put Vista on a diet and add some user interface chrome (all for the better, especially fixing the wireless UI which I find to be the single most annoying aspect of Vista).  In many ways, Windows 7 is Vista Service Pack 7.  The biggest competitor for Windows is always the previous version of Windows, so the recent “Vistaster” will be a boon.

In the last month I’ve heard from people seeing more recent builds there are still a fair number of bugs to fix, but it is going out hell or high water.  Microsoft is very anxious to put Vista behind them.  Figure a street date two months after it releases to manufacturing, so it could be in stores on new PCs as soon as July.

I think the product will be an unambiguous critical success from a product perspective.  But the big question is not the product but its impact on the business.  Microsoft has a very tough pricing decision ahead of it for Windows 7 on netbooks which are the only bright spot in an otherwise dismal PC market.

A great example of unintended consequences, netbooks started out as the Taiwanese PC industry’s response to the $100 One Laptop Per Child initiative.  But instead of being sold to kids in developing markets, consumers in developed markets are buying them as cheap second or third PCs.  And all the protestations you hear that they aren’t cannibalizing more expensive PCs are a sure sign they are cannibalizing more expensive PCs.

Moore’s Law has powered the industry for decades: you get twice the processing power for the same price you paid 18 months ago.  But there is a flip side to Moore’s Law (and one Intel in particular has feared for years): you also can have the same processing power as the last generation for half the price.  This is the dynamic driving netbooks which are now 10% of the PC market and the ramp is unbelievable.  Basically 0 million units in 2007, 15 million units in 2008 and a projects 30 million units this year.

Netbooks have had a bigger impact on the Wintel business franchise than all the anti-PC children’s crusades of the last 20 years combined.  Average selling prices of PCs have dropped by about a third due to netbooks.  Both Intel and Microsoft have chosen to eat their own young rather than let someone else do it, but it has come at a cost.  Intel’s CY-Q4 revenue was down 20% and you really see it in Microsoft’s CY-Q4 and CY-Q1 results.  Windows revenue doesn’t usually decline, much less faster than PC units.  The drop in the premium mix is even more precipitous (double digit hits in both of the last two quarters).  This is an ominous sign of declining pricing power.

Microsoft got its share back in the netbook space in 2008, but did it with sub-$20 copies of Windows XP Home.  So will they price Windows 7 to keep that share or protect revenue?  Starter Edition seems to be dead on arrival (in fact, to go back to a stock soundbite, you can’t spell Starter Edition without the letters D, O and A…), but they can always keep offering the immortal Windows XP if necessary.  Home Premium will protect the revenue, but it is likely to be too expensive for $300 PCs that are on a trajectory to a $100 BOM cost and will face a bunch of even cheaper Linux and Android-based competitors this year.  So the big question is will Microsoft go for units or dollars with Windows 7?

Google and the Enterprise

Google is just not serious here.  The outages and privacy-breaching data spills don’t help.  The economic situation means they have the tailwinds behind them and the shift to the cloud in general, but they just don’t seem to be serious about this business.  Is it a cultural thing where they’re just not willing to do what it takes?  It took Microsoft over 15 years to be able to say they got the enterprise with a lot of motivating/de-motivating beatings along the way.

A possible by-product of the soft landing is that the great Google land grab may be coming to an end.  Google’s window to throw new stuff at the wall and see what sticks could be over.  My guess is we’re seeing a cultural shift that can’t be reversed.  It is tough to dream big dreams and pursue ruthless efficiency.  Google has staked out a very lucrative and high growth franchise that they can very successfully milk for the next decade, but I think we’re less likely to see radical and disruptive thinking from them in the future as they optimize what they’ve got.

Microsoft
certainly benefited from having a long time window and multiple product cycles to invest in new businesses like the enterprise and entertainment.  Google’s window may have been much shorter (and in general I believe Google has followed the Microsoft arc albeit much more compressed.  To prepare for their next act I suggest they “lawyer-up”).  They have a great franchise, but they didn’t build any new franchises during the land grab.  So they’re still fundamentally a one-trick pony.