Cogblog

I talk to entrepreneurs all the time. Frequently, I look at their business plans and advise them on changes that could make them more fundable or likely to be successful. I wanted to document some of those ideas in a blog post that I could refer entrepreneurs to read. This could save everyone a lot of time!

This post is about building financial models for business plans:

I usually build the financial model after I have done the research to write a business plan and after writing a very rough first draft of a PowerPoint describing my business, but before I actually put very much work into the business plan. It drills down to monthly revenue and expenses and has some rollups to quarterly and annual figures. Without a financial model, I won’t have a sense of the kind of sales organization, pricing, or customer volume that I will need to have to be a successful business. I went to Wharton, so I like to look at the numbers.

My financial statements tend to have a similar structure with at least these tabs:

• Balance Sheet
• Cash Flow Statement
• Profit & Loss
• Profit & Loss Quarterly
• Profit & Loss Annually
• Revenue Model (If it is too complex to easily put in the P&L, which it usually is)
• Headcount - Line by line every employee type, quantity each month and how much they will make each month - this gets rolled up into some headcount and expense numbers used in other tabs
• Assets - If there are more than a couple of depreciable kinds of things, I will model that up because it doesn’t take me that long.  This is probably not necessary if you just make reasonable assumptions in the balance sheet and don’t have a business with a lot of capex.

Typically, the kinds of business I am interested in have very low capital expenditures – they are mostly about people and software – so my balance sheet and cash flow statements are pretty simple. Very little depreciation, simple AR and AP models, but the basics are there to understand how it has to grow to get profitable, financing requirements, and expenses. I suspect that if you had a business with an extremely complex capital structure, modeling the financials would be even more important.

I typically run my financial model out until I have at least a year or two of profits. Typically, I imagine that I am driving the financials towards some end-state model that represents how we would manage the business once it reached some more mature growth point. This is typically represented, in models I have built, by a revenue growth rate less than 60% year over year and margins around 20-30%. Usually the model goes out four or five years.  If your margins aren’t that high yet, then you probably haven’t reached a state as a business where you can command a strong valuation based on financials rather than perceived upside.  If you are still growing at greater than 60%  and your margins are that high, then you are throwing off so much cash, it always feels unrealistic to me.  When you don’t have to layout as much cash as growth slows, your margins probably vault to some number that seems big to me.

Study your financial model closely. I see the same mistakes time and time again:

• A large infusion of capital does not allow you to hire rapidly. You will not be able to hire people that quickly. Don’t assume you can.
• Look for big changes in expenses month over month and ask yourself, “Will I really be able to spend that much more money efficiently thirty days later?” The answer is rarely yes.
• Don’t assume you can raise capital quickly. Sometimes you can, but this is rare. Assume at least 9 months between financing rounds.
• Don’t assume salespeople will close deals for the first 90 days they are on board.
• Don’t assume you will be able to sell all of your web site impressions to advertisers. You need to keep a buffer just in case you have a slow day but you need to fill guarantees.
• Look at the quarter to quarter revenue growth: Is that realistic? Remember, your job may one day depend upon achieving that growth. Would you bet on it? It may behoove you to slow the hockey stick down a bit.
• Does it lack a hockey stick? Without an inflection point, it is not really an investable deal.
• What are your margins in the last year or two? If they are over 50%, then you are probably being too aggressive on revenue or too aggressive on expense management. Why? What good does it do to promise upfront that you will run the leanest, most capital efficient business in the world? Remember, these are commitments you are making to investors. Why not be a little more conservative on expense management (assume you spend more) and a little more conservative on revenue (assume you generate less)? You can still have a bang up business at 30% margins.
• Are you paying yourself enough? I don’t expect you to have a big salary the first year or two, but when your business gets big and has hundreds of employees, you should be able to go out to eat once or twice a year.
• Are you paying your CFO and head of sales enough? If you are building a big business, then these people have to be awesome. And if they are, they won’t be happy making peanuts as the business takes off.

It is always the same message: Your expenses are too conservative, your revenue is too aggressive and your growth and expenses are all too lumpy.

I am sorry, I can’t stop going after posts I disagree with on the web.

The head of Group M complains to Ad Age that if Yahoo isn’t competing with Google, search prices will rise:

“The party who bids highest and who achieves the highest quality score, comprised of price, relevance and likelihood to click, wins. And in a competitive market the price is capped by the incremental cost of the click to the advertiser in search engine A vs. search engines B, C or D and the total volume of clicks that the advertiser wants, needs or can afford.”

There are real issues in pricing in this specific monopoly (read here), but this economics theory argument misses the reality of the situation.  As Aaron Wall already pointed out, breaking down the data, you already pay more for clicks on Google, but that is only because the backend performs so much better.

Rob misses the target further:

“Inevitably, the per-click price of search will continue to rise if other channels deliver less volume and efficiency, and, if not capped by internal competition in the market, they will rise to a fraction below the costs of non-search channels.”

Err, I think the real economic theory here is that the price rises until the market CPA is exactly the same across channels.  For ease of discussion, a simple market like mortgage leads can be looked at.  Let’s say that a mortgage lead is worth $100.  If 10% of clicks turn into mortgage leads, then a mortgage lead firm is willing to pay up to $10/click.  If Yahoo offers worse converting clicks (as Aaron illustrates), then maybe the conversion rate is only 5%, lowering what an advertiser is willing to pay to $5.  If we are theorizing an efficient market, and that is certainly what he implies, then the backend performance will be equal across search and non-search channels.  If it is unequal, then there is an arbitrage opportunity and the advertiser is inefficiently spending in one medium or the other.

Now, search performs great, don’t get me wrong.  People are actively seeking things related to a product!  That is going to perform great.  But the result is higher per click prices in an efficient world, driving to the same back-end result.  This happens regardless of how many search providers there are.

How does internal competition in the market keep per click prices low?  Really, it isn’t about having lots of players, it is about optimization.  Better optimization provides better targeting.  More players doesn’t lower prices.  In fact, by distributing budgets across many algorithms, testing costs rise, creating potential inefficiencies.

VentureBeat, along with everybody else, covers a press release about the Pubmatic AdPriceIndex that I love, because it is data-driven, and will now proceed to pick apart because there is not enough data. In summary, this high level analysis of the data doesn’t really tell us enough about what is going on. Pubmatic should let us at the raw data so people can do a more nuanced analysis. Far be it from me to criticize people much, much, much smarter than me (PhDs!), but I think there are probably some aspects of the industry/Pubmatic offering that might not be understood and prevent the data from being controlled in a way that allows for effective analysis of the data set.

Anyway, I know I said in a previous post that I would try to be less harsh to people, but let’s dive in.

The most obvious question is with regard to the most prominent aspect of the press release. They announce that prices went down by a penny month over month. Of course, the first drilled down detail they offer is that small sites (under 1 million impressions) went down $0.32. They don’t provide compositional data, but it would stand to reason, given a data point like this, that small sites may have made up all of the penny shortfall. In fact, they do say that medium and large sites saw their CPM rise.

In fact, as their report spells out, big sites and medium sites have made higher CPMs every month! Maybe the recession is confined to small businesses? Not a chance.

So if we are saying that the penny shortfall was caused entirely by small web sites, the next question is how can we break down those sites. We have almost no insight into this, but one thing we can intuit is that they are working with many more small web sites this month than they did the previous month. If you read the June report, then you see that they worked with 3,500 web sites in that report, whereas they worked with 4,000 for the July report.

I bet most of those are small sites.

So they added a ton of new publishers to their service and prices fell. Web sites that weren’t being monetized previously or were being monetized poorly (either way, probably signs that it isn’t the most valuable inventory) signed up for Pubmatic, dragging price points down. That is not an unfair hypothesis.

One thing you could do is look at how publishers that participated in June saw their prices change month over month.

Alternately, the study indicates that as sites give Pubmatic more inventory, CPMs decline. Maybe they are signing up larger small sites (more profitable business for Pubmatic) and they are yielding lower new CPMs. Some analysis of how CPMs are linked to volume in Pubmatic’s system could explain this.

Considering even more alternatives, every ad network (and Pubmatic’s service) have testing costs. Maybe with the rapid influx of publishers and Pubmatic’s distribution of that publisher inventory over many advertising networks, the yield is artificially lowered by the need to test many new publishers across many new networks. Once again, controlling for the introduction of new publishers is important.

I am tired of typing now, but you can imagine the problems that might lurk in the other parts of the data. Incidentally, I bet that Pubmatic prints these great bio’s of the statisticians to imply that this is good, but I bet that at the very least the Chicago guy is embarrassed to be repping this data:

• Albert Madansky, Ph.D. is the H.G.B. Alexander Professor Emeritus of Business Administration at the University of Chicago Graduate School of Business, and was the recipient of the 2005 American Statistical Association Founders Award.
• Michele Madansky, Ph.D. is a media and market research consultant and former VP of Global Market Research for Yahoo!

Obviously, I work at an ad network, so don’t construe this as validation or not validation of what they are saying at all (prices rising, prices falling, don’t know and if I did I wouldn’t tell you).  It is neither.  This is simply a constructive critique of the information they reveal.

Clickety Clack comments on a ZDNet post that there might be a roll-up opportunity among smaller advertising networks. Implicit in his post is the concept that rolling together a bunch of 30-40% reach vehicles might give you some sort of 70% reach vehicle. That might happen, and I am certainly painting in fairly broad strokes here, but a lot of the inventory on these sites is Right Media and MySpace. To my way of thinking, almost anyone can rapidly build a network with 30%-ish reach by doing low frequency buys on MySpace and Right Media.

The real question is what the overlap in their advertising base is. If they actually have differing demand and are not all working the same CPA deals, there could be some leverage to a roll-up there. Unfortunately, there is basically no way of knowing from the outside what that opportunity may be.

Interesting article at MindValley Labs on Positioning, “Social Polarity” and Vibrant Blog Communities, however it only went halfway. They tell you that to build a great community, you need to take a strong position against something, then market the blog to appropriate communities taking into account the positioning.

Theoretically great, but that is quite a mouthful. No hints on how to market the blog to these communities or draw in commenters.

Me, I have always taken a direct response-ish position relative to all of this: Comments are a function of blog traffic. You probably (don’t know, never been able to test) get more comments if you get more traffic. Perez Hilton gets more than Fred Wilson who gets more than me. Does Fred Wilson have a polarizing opinion? Not really.

In an effort to give more than opinion, we crunched a little, tiny, minute iota of data. I wanted to compare Scoble and Fred Wilson, unfortunately, avc.blogs.com doesn’t show up in comScore, Quantcast, or Google AdPlanner data, so I had to eyeball with Alexa.

So Scoble and Fred Wilson get basically the same amount of traffic according to Alexa:

Here is a bunch of other data I rapidly generated.

Not the world’s greatest data set, but at least enough for us to have something to talk about. So Perez Hilton posts a ton every day, gets a ton of visitors and gets a boatload of comments. TechCrunch posts less, gets slightly less traffic than Perez and gets significantly fewer comments per post, Scoble and Fred Wilson post a lot less, get a lot less traffic, and Scoble gets a lot fewer comments per post. But Fred WIlson gets nearly as many comments as TechCrunch!

You might also note that the smaller sites tend to get more comments per post. Maybe this indicates a more vocal, hard core audience, though my hypothesis would have been that audiences follow some bell curve-ish distribution of active vs not active readers.

A more interesting way to further this analysis would have been to break down the comments and determine how many large an audience is actually generating them, modeling the vocalness of the minority at different points.

Regardless, we can probably safely say that, given Fred and Scoble’s traffic similarities, it is not strictly traffic correlated. Furthermore, one could conclude that opinion (polarization) matters less than one might think because Scoble tends to be thought of as more polarizing than Fred Wilson.

As I say all the time, turns out there is not an obvious way to build a blog community.

Today I had this sudden sensation that many of my posts tend to be about how things are a little harder than people expect them to be.

Today’s “actually, this problem is pretty hard” is based on an article in Advertising Age about Portfolio.com.  Portfolio.com is planning to extend the reach of their web site by buying exchange inventory, allowing them to sell more of their audience in the face of sold out inventory.

Advertising.com has been selling this off and on for years under the name “Audience Extend”.  Theoretically, this is an extremely powerful product for an oversold publisher because it gives them access to the exact same audience on relatively inexpensive inventory.  This can be valuable to an advertiser that is trying to reach this audience and valuable to a publisher eager to continue to take revenue.

I have always found that these deals are extremely challenging to make work because in a situation like this, the salesforce of the publisher (in this case Portfolio.com) is used to representing a premium inventory placement (it is sold out!).  Once you start working to educate the sales force about how to sell in a network model (sometimes blind placements, uneven, usually non-guaranteed distribution of advertising across placements, etc.), you are taking your sales force out of your sweet spot and asking them to do something different.  Furthermore, usually you need to find someone on the network side who is experience at the network model sales approach and involve them in either training or directly supporting the sales cycle.  Obviously, this is not a job you can ask your worst salesperson to do.

Given the margin compression that results from the network sharing revenue with the selling publisher, plus the cost of inventory, it can be hard to justify on the network side investing appropriately in the partnership.  In the same vein, when the network offers to put forth substantial resources, the publisher sometimes becomes concerned that the sales force may take their eye off the ball with the constant barrage of network rhetoric.

Managing partnerships is a delicate challenge that necessitates both parties investing significantly upfront to maximize the likelihood of success.  It will be interesting to see if Adsdaq and Portfolio.com make this work in any context outside of a one-off deal opportunity.

I am in Boston at An Event Apart today and tomorrow.

In Boston? Want to hang out? Email me pronto!

Regardless, this is great stuff for thinking about some of the problems of the Internet, although I have to admit this is a different crowd for me. It has been weeks since I attended a conference (I attended EconAds, Advertising 2.0, Graphing Social Patterns, and WebWidgetExpo in the last month) that didn’t kick off with “There are our Flickr tags, this is our twitter hashtag”. This is, for all of the roll-up-sleeves of the event, a slightly less geeky crowd in that respect.

It is also interesting because it is a rare event where I tolerate people talking for an hour and a half. However, because this is a series of deep dive presentations, it is working so far.

Jason Santa Maria with a great presentation on design completely outside my comfort zone. But it did make me think about something he didn’t directly mention but is correlated: Every web site starts with what is essentially a table of contents. How many people navigate magazines using the table of contents? Some. Not many. The New York Times doesn’t lead with a list of articles and authors.

SEO wants tables of contents. This is tension.

So everybody knows that Technorati has been flailing around looking for a business model.

Unfortunately, the business model du jour is Yet Another Ad Network.  So of course, Technorati announces they are starting an ad network.  The only thing that could have been more depressing in terms of expressing strategic genius would have been announcing a bidded text link marketplace.  Frankly, this announcement has all the same problems.

What makes business models like Glam have a prayer of success relative to ad networks such as Advertising.com and Yahoo! are that they have a very focused group of inventory and advertisers that they are matching up.  This allows them to have a smaller sales force and publisher services team and still have good coverage in their target market.

Technorati launches an all things to all people strategy and says they will be able to overcome Google/Yahoo/Ad.com due to their awesome contextual search technology?  To be able to pay publisher more, I think it is a function of two things: Optimization technology and a strong marketplace of advertisers to bid up inventory opportunities.  Contextual targeting is a tiny part of overall optimization and without the marketplace of advertisers, great optimization doesn’t create huge value because if you are decisioning off of one advertiser, there is only one possible outcome, regardless of how much you optimize.

I can’t see how Technorati overcomes the marketplace building barrier.  For that matter, virtually any company executing a YAAN strategy today puts themselves behind the eight-ball.  To get access to inventory, you have to pay higher than Google and Ad.com.  They are setting the marketplace floor because they have a strong enough market to buy every impression and offer something.  To pay more than Google and Ad.com, that implies that you have to have some level of optimization and the marketplace.  Glam did this by taking their tens of millions in venture capital and using it as a loss leader to overpay for inventory relative to the value of that inventory to Glam.  Technorati doesn’t have that capital runway, despite the $7.5m in new capital they just raised.

Odds that Technorati can focus on non-premium inventory and build a marketplace fast enough to reach escape velocity: FAIL.

I say all of this in a nice way.  I love Technorati.  Use it all the time.

A boring update long-overdue gets pushed live prompted by Chris Messina finding bugs in our OpenID implementation.

On the one hand, I tout our OpenID stuff as being interesting because we do a lot more handling pops and being Ajax-y than other implementations I have seen.  On the other, the result is a lot more edge cases and code.

The highlight of this update is the new changelog page where I will attempt to document all of the things that get broken.

After talking with Chris at the Graphing Social Patterns East conference, I am reconsidering another run at better and more interesting data dumps.  Chris was advocating introducing some custom rel tags.  I have avoided getting into the “creating standards” business, but, as a guy that seems to crank out a new standard every day, Chris was much more optimistic about the pending widespread adoption of the Cogstandard for modeling organizations.

He also thought I needed to incorporate uid stuff into my hcards and generally take advantage of the microformat marketing engine.  Not that many places make 50,000 hcards of data available to people!

As a guy that confessed on the panel he sat on that his internet consumption starts with ego-surfing, I am sure Chris will comment shortly with even more standards-based ideas.  He’s already debugging my other stuff, so that can’t be beat!

Just saw Facebook talk at Graphing Social Patterns.  It was basically a 45-minute ad for Facebook ads!  Drill down on their hyper targeting mechanisms, performance, etc..  As the speaker said, Facebook is an advertising driven business, so they walked us through their focus.

I think Facebook completely missed the boat here.  First, this is a geek conference.  They should have given this presentation at Advertising 2.0.

Second, I think this is not actually the optimal strategy.  What are they doing to help people using the platform make money!  Developers, developers, developers.  To justify a $15b valuation, what they need is an ecosystem.  They need multiple billion dollar companies using their infrastructure and then a tithing system to take a slice of the revenue.  To really scale, rather than focusing on selling their ads, they should focus on enabling people to sell their ads.

I love Google’s announcement that people can sell their own Youtube inventory.  Obviously, they are headed in the completely opposite direction by engaging the masses to make Google money.  Conceptually, they have the right strategy.  Tactically, they could still blow this - the minimum deal size of $10k seems to fly in the face of the validation Google has gotten around building a long tail of advertisers and publishers.  The smartest thing about this deal is that the concern with selling Youtube inventory has always been dicey content.  If people sell it themselves, then they represent their own content and ensure quality.  That essentially gets Google out of the quality discussion by having the inventory manage its own quality.  A slick solution to the problem.