How to Create the Next Facebook: Seeing Your Startup Through, From Idea to IPO (18 page)

A
freemium
means you have a fully functional free version of your product as well as a premium version. Because of this, it’s easier to get new users. Who doesn’t want to get a free product—especially one that provides a lot of value?

But the business model can be tricky. You need to have a low cost structure so you can make money from upgrades, which are based on a small number of users. The typical conversion rate is 1% to 5%. In other words, you need a large user base—say, over several million—for the freemium model to work. This has been the case with companies like LinkedIn, Evernote, Pandora, and Dropbox.

Once you have paid users, you need to make sure you provide strong ongoing support and innovation. If you don’t, you will likely suffer from attrition, which can kill the freemium model.

In Silicon Valley, this business model is red hot, but many entrepreneurs set themselves up for failure. Many types of businesses don’t have huge numbers of users, which means the freemium model probably won’t reach critical mass.

Data can be extremely valuable and can be the basis of a compelling business model. It’s been around for decades: companies like Dun & Bradstreet, Equifax, and Experian have made billions from the market. They have created extensive databases of customer information obtained from warranty cards, credit applications, magazine subscriptions, online forms, and so on.

But when it comes to using data from social applications, the level of skepticism is much higher. Perhaps it’s because the medium is new or the information is deeply personal.

Whatever the reason, there has been considerable pushback about using the data-selling model when it comes to social apps. This is not to imply that there is no business opportunity. But it needs to be done with a lot of thought and clear-cut disclosure to users. Still, given the potential of online data, it could be the launch pad of a hugely successful business model over the next decade.

Commissions have become a major source of revenues for Internet companies. This is especially the case for online travel companies, such as Expedia, Kayak, Priceline.com, and Hipmunk.

Commission revenues have two forms:
merchant revenue
, when the company charges the customer’s credit card directly; and
agency revenues
, when the customer is referred to a third party and a commission is remitted. Which is better? Probably the merchant revenue approach, even though it’s more expensive to implement. You have more control over the customer experience and should also be able to collect more information. In the end, it should result in higher revenues because a company has an easier time remarketing to its customer base.

A company may show growth—such as in users—but not have a viable business model. An example is ICQ, which was one of the early players in instant messaging during the late 1990s. It quickly gained millions of users but was unable to generate much revenue. ICQ was essentially a feature, not a company.

When this is the case—and it’s common—the best strategy is to sell out. Over the long haul, it will probably be quixotic to find a business model that works. In the case of ICQ, the company accepted a buyout from AOL. The huge Internet powerhouse liked the company because it gave users another reason to come back, which increased the opportunity to boost ad revenues.

On the other hand, a company’s business model may generate lots of revenue but still have inherent danger. A typical scenario is when a company relies on major suppliers. This has been the case with Netflix. To build its highly popular video-streaming service, the company must invest huge sums in gaining access to premium content. The problem is that it has little negotiating leverage because it competes against mega-companies like Amazon.com and Comcast, which can pay even higher prices for content. Those competitors have the luxury of making up for the revenue shortfall by relying on their other businesses.

To avoid these kinds of business-model problems, you need to think about potential vulnerabilities. Is your product mostly a nice feature, or is it a stand-alone product? Might a larger competitor outbid you for content or distribution? Going through numerous scenarios is a very helpful activity and can help to avert disasters.

When you’re brainstorming and iterating your business model, there are some key things to keep in mind. Bill Gurley (a venture capitalist at Benchmark Capital, which has funded companies like Twitter, eBay and Instagram) wrote a blog about this topic and set forth some helpful factors.
¹
Here’s what he looks for:

• Sustainable competitive advantage:
  You need a way to deal with rivals for the long haul. It could be a great brand, network effects, or a strong infrastructure. Some companies have all three, such as Microsoft, Facebook, and Apple.
  
• Predictable revenue:
  Quarter after quarter, a company needs to increase its revenues. This should be not only because of a growing market but also due to strong pricing. At the same time, existing customers will continue to come back—and usually buy more of the company’s product.
  
• Customer retention:
  This is a major factor for Facebook. Just imagine the hassle of reconstructing your social graph somewhere else!
  
• Gross margin:
  This needs to be over 70% or so. As you saw in
  Chapter 8
  , a high gross margin means much more latitude to invest in the product and marketing. It’s also important that the gross margin tend to increase as revenues increase. This is a sign of a powerful business model.
  
• Customer fragmentation:
  A business model has risk if one or more customers represent over 10% of overall revenues. The reason is that they may have leverage in getting better terms. The ideal is to have a large customer base.
  
• Marketing:
  As much as possible, there should be small outlays for this expense item. Of course, Facebook had the advantage of being a highly viral platform that has been able to attract millions of users at extremely low costs.
  

This chapter has looked at how Facebook has evolved its business model and found highly effective ways to generate profitable revenues. You’ve also seen some other innovative approaches and considered some of the risks. It’s important to remember that you probably won’t figure out the right business model early on; it takes time to experiment. But a product generally has just one optimal business model.

The next chapter covers the often-mysterious topic of being a CEO. And yes, Zuckerberg has some extremely helpful lessons.

Leadership and learning are indispensable to each other.

—John F. Kennedy

Have you heard of Jonathan Abrams? Unless you are tied into Silicon Valley, you probably haven’t. Jonathan created Friendster in 2002; it was one of the first social networks. The site was an immediate hit and should have become the dominant player in the space, not Facebook.

Friendster raised substantial amounts of venture capital from tier-1 players like Kleiner Perkins Caufield & Byers, and Benchmark Capital. The company also received various juicy buyout offers, including one from Google.

Yet a couple of years later, Friendster imploded. There were many reasons—including destructive internal politics and too much focus on getting media attention—but a key problem was that the company had a feeble infrastructure. When millions of users hit the site, it slowed to a crawl. It often took over a minute for a page to appear!

Mark Zuckerberg learned some valuable lessons from Friendster, thanks to the fact that Peter Thiel, Reid Hoffman, and Sean Parker were Friendster investors. But avoiding mistakes was just one part of making Facebook great. Zuckerberg also needed to make strategic decisions about the product, business model, and funding. In other words, he needed to be a great CEO.

This chapter looks at some of the key takeaways from Zuckerberg’s journey. The good news is that you don’t have to be a natural-born leader to be a great CEO. It’s definitely something that can be learned.

In the early days of Facebook, Zuckerberg was a terrible CEO. He didn’t communicate well, he kept things to himself, and he often riled his employees. He also had a bit of an attitude. One famous example was his business card, which had the following at the top and bolded: “I’m the CEO, Bitch.”

In late 2005, things were getting worse. Zuckerberg was spending most of his time hanging out with media moguls, flying private jets and dining at elite restaurants. These pastimes may have been a great ego boost, but they were taking a toll on Facebook’s employees. Was the company up for sale? Would the owner be a global media conglomerate? Employees were becoming demoralized, and it was harming the company.

Trying to get things back on track, the company’s in-house recruiter, Robin Reed, confronted Zuckerberg and said, “You’d better take CEO lessons, or this isn’t going to work for you.”

It was a pivotal moment—and a wakeup call. Zuckerberg was mature enough to evaluate the criticism and act on it. It was a valuable lesson and critical for the company’s growth. From that point on, Zuckerberg set out to get CEO lessons from people who included some of the world’s best leaders: Steve Jobs, Marc Andreessen, Jim Breyer, Bill Gates, and even Warren Buffett.

But perhaps the most influential—at least during the critical early years—was Donald Graham, CEO of the
Washington Post
. The two had an instant rapport. Zuckerberg was impressed with Graham’s long-term strategic ideas about building a company that thrives across generations. To soak up information, Zuckerberg followed him around the offices.

No doubt, being a CEO can be lonely. You can’t say something like, “I have no idea what to do. Any suggestions?” To do that would be a killer. This is why it’s important to find mentors, as Zuckerberg did—especially those who have several rungs more experience than you.

But a CEO also needs to encourage an open environment. Employees should feel free to say negative things. If they don’t, it will be nearly impossible for the CEO to understand the company’s problems, especially as it grows at hyperspeed. The very fact that Reed was able to criticize Zuckerberg was an encouraging sign that Facebook had a culture of openness; and this became an element of his
Hacker Way
.

Zuckerberg’s mistakes in the early years provided him with another crucial lesson: the perils of corporate imprinting. This is a natural human behavior in which employees copy their leader. If the CEO wears a hoodie, guess what?
Everyone else will. If they take up smoking, get ready for many employees to do so as well. And if the CEO gets married, expect lots of wedding invitations.

It’s almost comic, but it’s very real. This is why a CEO needs to be constantly aware of their own actions. How will they be interpreted? Is the right example being set? What about the nuances?

These questions can be vitally important for young CEOs, who may be on the wild side. This became a problem in the formative stages of Facebook, when the corporate environment was more like a raucous college dorm.

Having fun is a good thing, but there are boundaries. When things go too far, a company can alienate its employees and even trigger lawsuits. It may also result in chaos, which can make it tough to get things done.

Zuckerberg began to see problems emerge, and he took swift action to bring more professionalism to Facebook. He definitely set an example when he pushed out Sean Parker, who was an unabashed partier.

Unfortunately, it seems as though many of today’s startup CEOs are not taking this approach. One example has been Groupon’s CEO and co-founder, Andrew Mason. Since his company came public in late 2011, the stock price has plunged. A big problem has been the issue with the accounting and the financial system.

In 2012, Mason began have town-hall meetings with his employees to focus on finding ways to make the company more professional. Yet at the first meeting, he was drinking beer—and he burped! It was funny, but it continued the organization’s goofy tone. It was so over-the-top that the story landed on the front page of the
Wall Street Journal
. It was the kind of PR the company didn’t need and investors didn’t want to see.

Beyond focusing on creating an open environment where criticism is encouraged, and understanding the dangerous consequences of corporate imprinting, what are some other best practices for budding CEOs? The rest of this chapter looks at the key factors of Zuckerberg’s journey to becoming a great CEO.

As your business gains traction, you will inevitably attract lots of interest from third parties. There will be requests for partnerships or even buyouts. Of course, many salespeople will try to sell you stuff.

All of them will be convincing and complimentary about your company, but don’t get sucked in. Perhaps one of the most valuable traits of a successful
CEO is the ability to say “no.” Otherwise you’ll get sucked into too many trivial activities, which means not having enough time for the important things.

In some cases, you need to put a stop to certain projects because they show few signs of success. It’s not easy to do, but the costs of continuing such endeavors will only stunt your company’s growth.

Zuckerberg has nixed many projects, such as a social calendar and the Deals business, even though significant resources had already been invested. But it didn’t matter, because the efforts were not getting much interest. As the saying goes, “Fail fast.”

Competing against mega-companies is daunting, and it may seem impossible to prevail. But there is something a small company can do that a big company can’t: move fast. Always keep this in mind. It’s a key advantage.

As your company grows, it’s easy to allow friction to seep in. A CEO may become cautious and start avoiding risks, which is a natural response. But according to Zuckerberg, a company needs to keep moving “fast and break things.” If you aren’t making mistakes, then that’s when you know you aren’t working fast enough.

It’s true that you should continue to engage in vigorous debate and analysis when making decisions. But you need to do so with urgency.

Zuckerberg has taken a direct and quick approach to making decisions. This means clearly stating his positions, listening to others, and then taking clear-cut action. This approach can seem impersonal and harsh, but it’s necessary for success.

Politics are the enemy of innovation. If employees are more concerned about their own agendas—and career paths—then they are about the business—it will be tough for a company to grow for the long haul.

Although politics can never be eliminated, they can be managed. Consider that Zuckerberg has made this a focus of his Hacker Way, which declares

Hackers believe that the best idea and implementation should always win—not the person who is best at lobbying for an idea or the person who manages the most people … Code wins arguments.

This approach is worth considering for your own venture. It should help keep up your company’s momentum and unleash innovation. But it’s critical that the CEO frequently talk about the importance of focusing on results, which must become part of the company’s DNA.

Many CEOs delude themselves: they ignore information to the contrary and think their business is doing well. Even CEOs of public companies have been known to do this.

During boom times, it’s possible to thrive with this approach. Just look at the dot-com era. Showing metrics such as surges in users was enough to raise huge amounts of capital. But when the VC market collapsed, many companies were wiped out. Only those that focused on sound business models—like eBay, Priceline, and Google—were able to survive the nuclear winter.

To be a great CEO, you need to constantly track data and understand the trends. Although the implications may not always be clear—at least in the short run—you’ll be in tune with the reality of your company.

This is a big one. A CEO should not accept the conventional wisdom. It’s often wrong!

Zuckerberg has always been good at asking his team “Why?”—especially those who say something can’t be done. This approach has been effective in reaching deeper truths, which may point to great product ideas or innovative business models. For example, when he thought about having a photo-sharing concept, it seemed like a bad idea. Did the world need another way to share pictures? But Zuckerberg found a way to use Facebook’s social graph to make his version a game changer.

He has also focused on getting to the essence of things. This means constantly striving for simplicity. Consider that some of Facebook’s best features include basic concepts like friends, Likes, and events.

This is something that Zynga’s Mark Pincus talks about. A
fake CEO
is someone who believes that image is everything. Such a person thinks of themselves primarily as a hot celebrity, not a leader who is focused on customers and the
product. A fake CEO would rather post on Twitter or opine on matters at conferences.

In the meantime, the company doesn’t have a real leader—just someone self-absorbed. Keep in mind that your employees have strong BS meters and should be able to easily detect when a CEO is superficial.

This is not to say that you should avoid publicity. As
Chapter 7
discussed, PR is a great way to help grow your company and to become a thought leader in the industry. But don’t believe your own press clippings.

A CEO needs to have a balance as well. Pursing the business on a 24/7 basis can quickly lead to burnout. Zuckerberg has dealt with this by setting a personal challenge each year. To meet one such challenge, he vowed to learn Mandarin Chinese; another year, he only ate meat from animals that he killed!

Setting these kinds of challenges is great, and they don’t necessarily have to be focused on your business. It’s better if they’re beyond it. Having an open mind can be a big help in promoting innovation and bringing new perspectives.

Since he was an early teen, Zuckerberg had a passion for creating applications. When he built something, it was usually a product he wanted for himself. There are cases where a successful entrepreneur may not necessarily be passionate about their business, but this can be tough to maintain in the long term.

Passion is contagious. It attracts top employees. It gets customers excited. It attracts the interest of partners. All these factors create a virtuous cycle, which helps to create great companies.

As you’ve seen in this chapter, there are no solid rules for being a successful CEO. All great leaders—such as Jack Welch, Steve Jobs, and Jeff Bezos—have unique approaches. Zuckerberg has evolved his own, and it has worked extremely well. The same will be the case for your own journey. Don’t necessarily copy from Zuckerberg: a better idea is to learn from his ideas and see how they fit with your vision.

The next chapter looks at an area in which being a great CEO is critical: building teams.