Episode 41: Booking.com with Jetsetter & Room 77 CEO Drew Patterson - Transcript

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Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

David: Drew, I think you might be our most prepared guest ever. This is great. Drew has printed out notes and pen and paper here. This is awesome.

Drew: I'm a big fan. I just want to blow my shot here.

David: Your shot at stardom. [music]

Ben: Welcome back to Episode 41 of Acquired, the podcast about technology acquisitions and IPOs. I'm Ben Gilbert.

David: I'm David Rosenthal.

Ben: And we are your hosts. Today, we are covering the 2005 Booking.com acquisition by the Priceline group. Now, this acquisition is legendary and there are tons and tons of sort of interesting nuances to understanding the industry. So we wanted to wait until we had a guest with deep travel experience and really industry domain knowledge to make sure that we did it right. So today, our guest and listener of the show is Drew Patterson, the CEO of Jetsetter and Room 77.

David: So yeah, we are lucky to have Drew who is a “grizzled travel industry veteran” to help us pack this one. So Drew started his career at Starwood Hotels where he managed distribution and pricing, and then jumped into the world of online travel at Kayak where he was VP of marketing from 2004 to 2009. He left to found Jetsetter – and thank you for doing that, by the way, because you guys booked Jenny and my honeymoon, so very much appreciated. And he was CEO there at Jetsetter until 2012 when he moved to the west coast and founded another travel company that was quickly acquired by Room 77 and he served as CEO there at Room 77 until the beginning of this year. So, thanks again, Drew, for coming on and sharing your travel industry knowledge.

Drew: Guys, great to be here. A long-time listener, first-time talker. Can’t believe I'm in this show.

David: We can’t either. We are ready to dive in.

Ben: We are. And listeners, if you listened to last week’s episode, you may know this but if not, we are skipping the bit about asking for reviews and letting you know about our Slack this time with an extremely important message. We are launching the annual Acquired survey and we’ll have it open for about a month. So whether you’re a first-time listener or a long-time fan, we would love to hear your thoughts and in fact this is so important to us that it’s actually more important than any reviews, any begging you to share with your friends, any of the normal stuff that we do because as you guys know, we often lament the lack of data available to podcasters and it's really important to us to learn more about who you are. Some of those reasons include, number one, we need your honest feedback about how to make the show better and based on some of the early responses we’ve already read, you guys have been fantastic at doing that, so please help us out, tell us more information. We’d like to understand who you are so we can better tailor the content and the guest to our audience. Then third, we’d like to learn more about who you are to share completely anonymously without any identifiable information with our sponsors to really help them paint a picture of who’s listening out there. So that's about all I have to say about that except that we are sweetening the deal by saying that we will be raffling off one pair of Apple AirPods. So if you’d like to be able to be eligible to win a pair of AirPods, click the link in the show notes. Go to Acquired.fm/survey. It will take about 5 to 10 minutes and we would really, really appreciate it.

Our sponsor for this episode is Silicon Valley Bank. This week I got a chance to talk to Shai Goldman. Now, Shai is the managing director at SVB out of their New York Office and was previously a partner at 500 Startups. We talked about the New York tech ecosystem where Shai plays a major role and I asked him for his take in Priceline since they’re a Connecticut-based company.

Shai: “I think the interesting thing about Priceline is they’ve made a lot of great bets in picking up smaller companies that generated significant impact to the topline revenue. So from what I understand, the majority of their current revenue has come from 4 or 5 acquisitions that they’ve done in the last sort of 5, 6, 7 years. So they’ve done an amazing job buying smaller companies and that sort of helped them grow and become a huge part of their revenue stream.”

Thanks, Shai and SVB for the sponsorship, and also for the perfect, perfect tee-up to our episode today. If you want to learn more about SVB or reach out to Shai specifically, you can click the link in the show notes or in the Slack. So David, are you ready to take us into the history and facts?

David: Let’s do it, as always. So many people, at least here in the US, I think aren’t totally aware of Booking.com because it’s very big in Europe but not as big here yet in the States, and they probably also don’t know that it’s actually owned by Priceline. And if people in the US think about Priceline, they often think about William Shatner and the Priceline negotiator which is definitely a big part of Priceline and internet history. But that's a story for another day. But today, we’re going to talk about how Priceline of which Booking is by far the majority of it, is actually the largest travel company in the world. And after SAP, I think it’s actually the second largest tech company that's ever been built in Europe and as a $91 billion market cap – that's billion with a B. So just for some reference, that's equivalent to three Airbnb’s and it’s bigger than Netflix. So it’s not a company that a lot of people know about but it is definitely top 10 most successful internet startups probably of all time.

Ben: Yeah. When I said legendary earlier, I mean that stems from when we first started doing the research for this and you just started seeing some of the high-level stats of what an enormous company this is and what a behemoth in the travel industry, I think to Americans and even some Americans in tech, we don’t know much about this company.

David: Well, and that's why we have Drew here today. So I’ll start out with the history and facts, and Drew, please feel free to hop in at any point along the way. But the company was actually founded in Amsterdam in the Netherlands in late 1996 by Geert-Jan Bruinsma. And major apologies to all of our Dutch listeners and to Geert because I'm sure I just butchered that. But he had just graduated from college and this was late 1996 and felt kind of in his core that the internet was going to be a thing. So he decided rather than going to work for a company like most of his classmates, he was going to become an internet entrepreneur. But there was just one problem. He didn’t have an idea. So he starts casting about for an idea of what type of company he would start and apparently, according to this great, great oral history of online travel that the website Skift published that we’ll link to in the show notes. But according to an interview with him in this oral history, he was having dinner with some friends one night and they were talking about problems that they had and they realized that booking travel across Europe was actually a really hard thing in those days because you had to call up the hotels that you wanted to stay at on the phone and of course in Europe people speak all sorts of different languages. So if you didn’t speak French and you wanted to book a hotel in Paris, you were kind of out of luck. And he thinks to himself, “Well, I bet this is something that the internet can solve.” So he goes and starts doing some research and he thinks well there must be other folks out there that are already attacking this problem.

But it turns out that there were no major online travel companies at that point. Some of the hotels in the US had started having their own online booking system, so he went on The Hilton website. He actually looks at the code for Hilton.com and takes some “inspiration”, according to him, from how they managed their online booking system. But he pretty quickly codes up an MVP for a multihotel booking website.

Ben: David, if only there were someone to aggregate these disparate one-off hotels that had their ecommerce system.

David: If only. And he calls his little project Bookings.nl (NL for the Netherlands). And that is how Bookings.com was born and in the early days, unsurprisingly again, it was actually mostly Americans that used the site. Americans who were traveling to Europe and looking for a way to book online. Because in those days, it was only Americans that really had access to the consumer internet. There was AOL at the time, lots of common people in the US were online but in Europe, it was much more still of a kind of confined academia type thing and average Europeans didn’t have access to the internet in the same way. So ironic because Booking ends up becoming such a large company on the back of European customers but the initial customers were Americans.

Ben: Yeah, and it’s really easy to forget too sort of the roots of the internet in sort of American University and defense infrastructure, like of course it's not elsewhere in the world yet. It was brand new and it was invented in the US. It’s kind of shocking to imagine a world where people are playing around with websites. In the US, Amazon is being founded in the mid ‘90s but it hasn’t really made it everywhere else yet.

David: Yup. It was a different time. And also a different time, venture capital and in particular venture capital in Europe was a very, very different kind of proposition and Geert had a tough time getting funding so what he decided to do, and again, he talks about this oral history and I just love this, he needed funding so he decided that he was going to email everyone who he knew who had an email address because he figured if they had an email address, they at least knew something about the internet. That's a direct quote from him. I just love that. So he emails about 50 people and 18 of them end up investing. He raises about 50,000 euros to get going, hire some early employees, and they start to get off to the races. What they evolved into, and this is where we’re going to spend the bulk of this episode and I want to bring Drew in here, they really become one of the first online travel agencies. So the same general model as Expedia or Priceline or Orbitz or Travelocity here in the US. There are kind of three pieces to the business that they started. One, they need to acquire the travelers. Two, they need to acquire the hotels, the supplies, the supply and demand. Then three, they need to provide some form of customer service. So Drew, for our listeners who aren’t as familiar with the OTA world, how did all this evolve?

Drew: You got the basics of it, right? All these businesses really are a marketplace. It's about how they bring together a supply and demand. It’s interesting to think back to where this industry was as Booking.com was starting. We’re talking a little bit about who had email addresses and it was all AOL, it was MSN, it was all these kind of dial-up services. We forget it now but the real things that made the first generation of OTA businesses in the US were like [___ 00:12:04]. Do you remember these? It was like Travelocity got the deal on Yahoo and therefore Travelocity was by far in a way the leader in this category but actually, Travelocity managed to get a couple of those. It was AOL, it was Yahoo. I forget which the other ones were.

David: And of course, Expedia founded by Richard Barton up in Seattle was part of Microsoft in the early days so they had MSN of course.

Drew: Exactly. So they had that as a pretty healthy lock-in towards the demand. The other side is, exactly as you said, was how do you start to get then a supply base that fits with that? Again, early days, the internet, not that different like than a newspaper, right? What are all the kind of categories of interest and how do we start to fill them out, travel being one of those? And so what you saw with the first generation of these online travel agencies was they’re basically just a front end to the GDS system (the global distribution systems) which were used by travel agencies to make flight reservations, make hotel reservations and the like. So you had this kind of big supply base that was already in place. Travel agents always got commissions and this GDS has provided travel agents with rates and availability, the tools to go ahead and make a reservation on a consumer. Expedia and Travelocity and the like were front end that the average consumer could use.

David: That's one thing actually I hadn’t focused as much on. But could you talk a little bit more for our listeners about this whole GDS system? Because it existed before the internet, right?

Drew: Yeah. It goes back to I think it was 1973 when the first GDS was built. These were actually by-products of the airlines. So American Airlines, Bob Crandall famously realized they needed some computer system to tie all their travel agents together and that was the genesis for Sabre which is the very first GDS. And of course that then served as the underpinnings for all these online travel agencies for a long time.

Ben: Wow. The parallels to the real industry are amazing here where you look at the MLS systems existed long before you had Zillow but they’re sort of this – David, you mentioned Rich Barton, this Barton-style “data to the people” way where you can take these systems that should just be corrigible by the general public but have been locked up by a professionalized industry for a long time and it really makes you wonder like what else is out there that has private databases that are linking the industry together that really have the potential to be brought online.

David: Yeah. So for Booking and in Europe, obviously there’s the GDS in America. Did the GDS extend to European hotels as well?

Drew: Yes. So an interesting point that kind of drives up the structure of the industry and I think part of what set Booking up for success over time. If you think about what kind of hotels were on the GDS, it was a certain kind of hotel. Like rough and tough, there are 500,000 hotels in the world. Of that population of 500,000 –

David: Which is crazy, by the way. I think a lot of people in the travel industry don’t realize that, like 500,000 hotels in the world, that's a lot.

Drew: It's a huge number. That’s why Trip Advisor would tell you they’ve got hotel reviews. So again, that's kind of the biggest sample of hotels. But the GDS only has about 75,000 hotels on it, varies a little bit from GDS to GDS. But the kinds of hotels that are generally on the GDS are, well, going back to our example, it’s the Hiltons of the world, it’s the Marriotts of the world. It’s the kind of hotels that get booked by travel agents which tend to be stayed in by business travelers or folks that historically accessed travel agents and so they were franchised and more sophisticated and had better technology. It wasn’t a 20-room pensione outside of room which is much more commonly used by the European traveler.

David: That really speaks to – we’ll get into this throughout the episode but the differentiation and the value that Booking was able to build while it was really hard in the beginning and we’ll get to they end up getting acquired by Priceline in 2005 for $133 million, I mean, nobody recognized the value here. But because they were able to build this proprietary longtail marketplace of supply, they really had something no one else could access. It reminds me in a lot of ways of the difference between Google and Yahoo. Like on Google, you could type a query on Google and they had access to the entire longtail of the internet whereas Yahoo with the directory model only had the head. So for people, Drew, like you were saying, you’re looking for something specific in Europe, it was Booking or nothing.

Drew: A hundred percent. I think that's a great analogy. Where that really becomes clear, I guess we’re kind of jumping ahead –

David: Oh, we always jump ahead here.

Drew: But if you think of like what’s the advantage of having the tail, it’s far greater relevancy. It's the things that you actually care about. The consequence of that is conversion rate. So again, not to get too far ahead of ourselves but the consequence of having all these kinds of longtail inventories, it’s far greater relevancy than those people who are relying on just the GDS might have enjoyed.

Ben: While we’re sort of on this topic of discussing that the OTA is basically a marketplace, Drew, before we kind of get into the future evolution here, could you do some sort of definitions for us of online travel agency versus travel aggregator versus metasearch, like how do these things interact and how are they different?

Drew: Sure. So the lines are a little blurry between them but in general terms, online travel agencies take reservations; they make bookings on behalf of the consumers and so they aggregate inventory from lots of different sources, generally directly from hotels, airlines, rental car companies and the like. Again, they will enable the consumer to make reservation. Whereas metasearch engines or aggregators are a layer of abstraction above that.

David: So it’s Kayak.

Drew: Exactly. Trivago. What like Trip Advisor has increasingly done, metasearch. What Google is doing today. They’re pulling rates and availability directly from suppliers, also from OTAs.

David: From OTAs themselves.

Drew: Showing you prices and to the consumers to decide what they want and then handing you off to an OTA or supplier to complete the transaction.

David: Got it. So let’s go back. We’ll kind of finish out the history and facts and then there’s a bunch more to dive into here. So a couple years go by, Booking starts to sort of slowly grow its supply base and its demand base in Europe, shifting as Europeans are coming online to actual European customers. One thing that's actually another side note that I would just want to put a pin in to come back to, on the demand side, we mentioned search engines, as search engines start to rise in prominence as kind of the front door to the internet, travel and in particular OTAs become one of, if not I think the biggest category of spend in terms of search engine advertising because the link between searching Google or whatever search engine for a villa in Rome and an online travel agency is you’re so far down the funnel, it’s a perfect type of advertising for these companies.

Drew: Yeah. Travel is a really nice use case for search advertising for a couple of reasons. The two biggies are, number one, it has high purchase value so they’re relatively large transactions; and number two, it’s a very close combination between search and transaction. So online searching for a home, online searching for a car. All these are completed online and so as a first case of direct response advertising, travel is a really big use case. And so again, you saw the OTAs as one of the biggest categories of spenders on Google.

David: So Booking is growing slowly. They end up merging in the year 2000 with another group also in the Netherlands, also called Booking, called Bookings Online, and that's when they changed the name to Booking.com. A couple of years go by and then in 2002, Expedia actually decides that they want to enter Europe from the US and they understand the European market is different, they need access to all this supply in Europe. And so they come over, they look at a bunch of players and they get very, very close to acquiring the new Booking.com. They do six months of diligence and then right at the end, right before they’re about to close the deal, the US Expedia board ends up rejecting the deal and vetoing it. The reason that they do so and this is the next kind of topic we want to dive into with Drew, is they’re really worried about Booking’s model which is different from the US OTAs, their business model. Booking uses the “agency” model whereas in the US, Expedia, Priceline, Travelocity and the like used the “merchant” model. So Drew, can you kind of help our listeners understand what the difference is between the two and why the US guys might have been so spooked by this?

Drew: It's funny looking at it today because it seems so obvious this agency model is great. But at the time the merchant model was highly desirable and leading to a lot of its success that the big players in the US had. So the big difference between the two, the merchant model is effectively a wholesale model. In the merchant model, the online travel agency contracts for wholesale rates with a supplier. So Expedia would go to Hilton and say, “We’ll pay you $100 for this room and we’re going to mark it up 20%, we’re going to sell it for $120.”

David: So this is the Amazon retail business analogy where Amazon is taking inventory on items, they’re setting the price and selling it.

Ben: In this scenario, the OTA actually holds the inventory risk, right?

Drew: No. This is why it’s such a great model. As an OTA, I don’t take any inventory risk. I'm just going to agree to what my net rate will be. If I don’t sell the room, it’s not my problem; it’s your problem. I can mark it up at that point in time as much as I wanted. So again, you had instances where one of the leading practitioners of this at the time was HRN which went on to become Hotels.com. But there are instances where they would have for New York City like on sold out nights, they would contract for a $300 rate at a Holiday Inn and they would sell it for $900 because it was the only inventory left in the city. It was like these guys are bandits, I mean, brilliant entrepreneurs.

David: Wow. If you can make this work, this is even better business model like it has the best of being a retailer and that you get to set the price and essentially control the inventory. But also, the best of a marketplace where you don’t take any risk on the inventory.

Drew: Exactly. One even better than that which is it has a negative working capital cycle. Because I collect money from the consumer when I sell this and then I remit funds to the hotel 30 days after you stay and if it’s a two-month average booking window, I'm holding everyone’s cash for 90 days.

David: Okay, so that's the merchant model. That's what Expedia and the US guys have. Now, Booking has the agency model. What’s that?

Drew: So the agency model was the kind of traditional travel agency model. That meant that they were going to take a commission, that commission was going to be paid not by the consumer. There wasn’t any kind of markup. But the supplier/the hotelier, in most cases, would pay them a commission based on what they sold and they would pay the commission after the booking took place. So if you don’t show up or there’s cancellation, again I don’t get my commission against it, and the commission rates tend to be much lower. Booking.com started at 5%. Typical industry commissions were about 10%, if you compare that to the merchant model which was 25% to 30% margins at the time.

David: And negative working capital.

Drew: And negative working capitals, exactly.

David: So you can see why you’re the Expedia board and you say, “This doesn’t seem like the right model here. These crazy Booking guys started by this college student, they have no idea what they’re doing.”

Drew: And to have some sympathy for them at the time, right? They were on top of the world. Travelocity had been the leading player, Expedia displaced them. Expedia recognized I think one of the interesting things about OTAs, when you look at their economics, what drives their business, it’s really the hotel business that drives their profitability. It’s a much more profitable piece of business than flights. Expedia recognized that early. Bought a company called Travelscape which was one of these kind of early merchant businesses. Then turned around and bought HRN which became Hotels.com which as it happened was powering the hotel business on Travelocity. So it’s kind of a master stroke. They completely undermined their competitor and they identified what the most profitable and exciting part of the business is and they controlled it all.

David: This is like when Google bought Overture.

Drew: Exactly.

David: This is great.

Drew: And now you want me to turn around and go buy something in Europe that's much less attractive?

David: So the Expedia board looks at all this and says, “We’ve got the golden goose here. We’ve got the best business model.” People say Google is the best business model of all time. “This might be even better. Why would we want to do the agency model?” But in the long run, of course, it’s the agency model that really wins here. What was it about that in the long run that ended up being better?

Drew: So the agency model ultimately was superior in part because it was a better consumer proposition. The merchant model wasn’t so great for the consumer because I had to pay you upfront as opposed to the agency model where I could cancel if I wanted to, I had a lot more flexibility. It also wasn’t so great for the supplier from the standpoint of a hotelier – I don’t really like this merchant model thing where I'm paying you 30%, you have more control over setting price, you’re keeping cash, not me. So that wasn’t great. But again, in fairness to Expedia board, they kind of looked at the world more like we’re in a dominant position, why do we need to move away from this? And I think what they failed to realize was just the size and magnitude of this market and just the power and potential of how quickly this was going to grow. That in combination with what we were talking earlier: the potential for ad words. A really kind of cost effective tool that would allow a business, an online travel agency to scale pretty quickly. And where those things came together was, again, going back to the point we’re making earlier was the longtail because this agency model made it really easy for Booking.com to clean up the longtail very cost effectively and very quickly. It was the much lighter weight approach in contracting, got a lot more hotels on board quickly. They didn’t have to go out and negotiate for net rates with an individual hotel. You can just fill out Geert’s form, send it back and away you go.

David: I forgot to put it in our notes but also in the Oral History with Geert, when he started, the way he onboarded hotels is he sent them postcards essentially with like a form to fill out on the card if they wanted to be included in the marketplace and then they just mailed it back to them.

Drew: Ecommerce at its best.

David: Yeah. Ecommerce at its best. MVP, bootstrapping.

Drew: The dirty secret behind the merchant model was for the longest time, I mean literally up until probably five years ago, like a huge chunk of reservations were delivered by fax machine. Well, maybe it was 10 years ago.

David: A lot of these hotels might not have had internet connections. So it was kind of like the early days of the food marketing Grubhub and Seamless. Those were all orders delivered by fax machine too.

Drew: Yeah, totally.

Ben: Internet. Let alone having Wi-Fi marked on your Booking.com reservation. One point I want to make here before we move on is that there’s an incredible similarity to the ebook market here. When we talked with Brad Stone, I don’t think we discussed this on the show since we were talking about the Uber-Didi deal, but he talked so much in The Everything Store about the struggle that Amazon went through with ebook pricing and the wholesale versus the agency model there where Amazon kind of prefers this wholesale model where they can pay a fixed price for something and then they have all the pricing control and can mark it up and down however they want and they have incredibly sophisticated variable pricing to do that. But the sort of I think it was the European, some kind of EU book consortium that really had a lot of power in this industry and forced them to use the agency model and it was a big concession they had to make when going to market.

David: That must have been a big piece that ultimately led to the development of marketplace within Amazon.

Ben: Got to be.

David: Which is why Amazon is what it is today. Power of marketplaces.

Ben: It is. That's truly one of my favorite things about this show is like seeing the patterns between different industries. They evolve at different speeds, they evolve with different waves of technology but at the end of the day, there’s really only so many business models and there’s really only a finite number of ways that different players in the industry can interact with each other and we kind of see the same playbook roll out over and over again.

David: Are you making an apologist argument for venture capitalists, Ben?

Drew: You might think.

David: We’re not self-serving on Acquired at all. So back to the history and facts. All this happens, Expedia ends up passing, leaves Booking and Geert at the altar. Then Geert makes a decision which probably when he talks about this made the right sense for him at the time, they’ve just had this deal fall through, he ends up selling Booking.com not to Priceline but to an investor group. So a major European investor group, a consortium comes in and acquires a majority stake in Booking. This is in 2002-2003. Then over the next couple of years, there’s kind of one guy sort of in the US that starts to see what we were just talking about with the power of the agency model and starts to wonder about the future of how long kind of the music can keep playing with the merchant model, and that guy’s name is Glenn Fogel who is now the CEO of the Priceline group which includes Booking, of course. But at the time, he was Priceline which was just Priceline, the Priceline group also includes Kayak and Open Table now, perhaps future shows. But at the time, Glenn was the head of M&A for Priceline and he comes over to Europe and he starts digging and realizes this dynamic with the agency model that it really does align interests better and incentives between the travelers and the hotels. And not only that, but people in Europe also travel a lot more than they do in the US because we’re workaholics here, we don’t take as much vacation so you’ve got kind of a better product model, a more active customer base, and he starts to argue within Priceline that they should really start acquiring some of these companies.

So the first acquisition that they make led by Glenn is actually not Booking but a company in the UK in Cambridge, England called Active Hotels, which is very similar to Booking, was larger in the UK than on the continent. They acquire that in 2004 for 165 million. Then later in the summer of 2005, they do finally acquire Booking for 133 million, as we mentioned. They merge it with Active Hotels in the UK and they keep the Booking.com name, so they combine the entity as Booking.com. When they do that, in total, they now have 18,000 properties across all of Europe, 18,000 hotels on the system which is way, way more than any other online travel agency in the whole world. So Priceline, this is kind of a master stroke, they build through acquisition the largest online travel agency in the world with sub 200 million deals. Kind of amazing.

Ben: Yeah. So question for Drew is, do you think that they needed to do the acquisitions to do this, to sort of like bring that agency model into the Priceline group or could they have taken their existing supply and demand since they already had some scale and really reinvent that and kind of copy that model themselves.

Drew: I think it’s tough to see and I guess it particularly plays out when you look at sort of subsequent history. I think it’s tough to see Priceline doing this on their own. In part, I think you have to look at the context for Priceline to make this acquisition, why they’re able to do it. Priceline made efforts to go to market in Europe. Again, remember this is 2004, this is kind of the depths of the dot com buzz. Priceline had been one of the biggest success stories of web 1.0 like we all remember William Shatner, Delta made a billion dollars getting warrants in Priceline, selling them at the top of the market, looked like a genius. And Priceline had moved in to “Name Your Own Price”. Dog food, name your own price. Groceries, name your own price. It was just like all over the place.

David: There’s a great history or partial history of Priceline in the internet bubble in the book eBoys which is about the early days of Benchmark, the venture capital firm. They were the venture investors behind Priceline and the initial Priceline, it was crazy. Drew, like you said, it evolved into travel because that was the only thing that made sense that they did, but originally, it was name your own price for anything.

Drew: So these guys didn’t look like masters of the universe at the time. They looked like yesterday’s news who were trying to figure out a plan B. Priceline had actually tried to go into Europe. I heard the story once that they hired like a former marketer from Burger King to make Priceline “Name Your Own Price” a big deal in Europe and totally flopped. So you could imagine Glenn sitting in Priceline but like no, no, we need to go back to Europe and we need to get big in travel. It wasn’t like they were coming from a position of strength where they had both the capabilities and position to do this. I think, again, it’s absolutely to Glenn’s credit to recognize what they did. A common position for a lot of the US companies. Travelocity tried to go into Europe. Expedia tried to go into Europe. A lot of these companies had tried to go into Europe and really struggled. I think one of the reasons for that, and again, we kind of touched on it briefly earlier, it’s the cultural issues. For big US companies, the US was this kind of dominant formative experience. Everyone speaks the same language. You have national advertising. You are building a single monolithic brand that serves across the US as a market. Europe doesn’t really work that way. UK is a different market than France, than Germany, than Spain, than Italy, than the Dutch. They all have their own languages, they all have their own domains like they all have their own marketing channels. You have your own country managers. It’s a much more complex and nuanced way to serve in the market.

You can see why some of the US travel companies really struggled as they tried to build this on their own, and why, from the standpoint of somebody like Glenn, the thought of hiring some Dutch who probably speaks a bunch of different languages, know how to work all these different cultures, go let them do their thing.

David: Well, and to their thing they did. Another kind of theme that we see on this show a lot is Glenn and the Priceline group left them alone to do their thing and so they acquire them in 2005, they complete the merger within Priceline of Active Hotels and Booking.com. In 2005, they do collectively 18.7 million room nights booked, or sorry, that was in 2006 after the merger. And that grows from 18.7 then over the next 10 years such that last year, 2016, they did over half a billion room nights. So that's over 40% growth per year for 10 years and the financial zones now are just pretty staggering. I mean Priceline, the company, the group as a whole did 10.7 billion dollars in revenue in 2016 and of that, Booking.com which again, remember they paid a combined, what is that, 290 million dollars for Active and Booking. They did 7.8 billion dollars of that. Pretty incredible.

Ben: Amazing they break that out too because I think while they’re separate properties, Drew, do you know if they cross-pollinate the supply between the frontends for Priceline.com and for Booking.com?

Drew: No, they don’t. They have their own supply teams. I think of the things that has defined Priceline’s management strategy is the group has let the businesses do their thing. So again, today, Priceline is Kayak, Agoda, Booking.com, the core Priceline brand, car rentals, and Open Table.

David: They have a car rentals business too, yeah.

Drew: But each of those businesses has been largely left to fend for itself and make decisions that are right for its business. They don’t really do a whole lot of kind of corporate level cross-pollination and especially at this point in time, so more recently they’ve done a little bit more but certainly through these incredibly explosive years of growth, each of the businesses are run autonomously.

David: And so that kind of wraps up the history and facts here, but one just sort of fun side note in doing the research that Drew, I had wanted to ask your thoughts on, what’s really crazy to me, this is such a big market. Again, Priceline group, when we said at the top of the show, $90 billion market cap, that's three Airbnb’s and more than Netflix. And it’s not like Expedia is a small company either or any of these other companies. But the industry is so small people-wise, like it’s a total cabal and like reading the Skift Oral History and all of these folks who are the major players bounce between company to company. I mean, even you, you’ve been at Jetsetter, you’ve been at Room 77. It’s all such a small world. Why is this not flooded with entrepreneurs?

Drew: Gosh. A great, great question. In part I would say there was a moment where it was flooded with a lot of entrepreneurs. There’s a lot of company formation that led to these businesses. So if you look at take Expedia today, Expedia is the sum of Expedia plus Travelocity plus Orbitz plus Wotif. Travelocity was a combination of Preview Travel and Travelocity.

David: And Hotwire is in there too.

Drew: Yeah. Hotwire is in the mix. So you have a ton of businesses that were built that ultimately have consolidated to a relatively limited number of two platforms, Expedia and Priceline. I guess you can look at Ctrip, it’s the third one in Asia, maybe Trip Advisor.

Ben: Yeah. And I think also the amount of required connectivity between all these different entities is kind of a high technical bar to get started and I think that these businesses, kind of aggregation theory in play here, are scale businesses so that in order to provide a lot of people have new ideas for how to make the travel booking experience better and the trip planning experience better, and I think it’s almost become a trope that like if you go to a startup weekend, you’re going to see somebody pitching a better way to plan trips and do something in that space, but it seems like it’s just really hard to execute as the bar has gotten higher and higher with these established businesses.  

Drew: For sure. I certainly see a number of entrepreneurs want to pitch ideas for better startups. The question is, what does better mean this category? I think Booking has been the illustration that better, as Booking defined it, is higher converting. One confuses consumer satisfaction with business model efficacy. If you can find a way to get more clicks or more bookings out of a given visitor, you’ve got a better mouse trap, but that's a less sexy idea than helping people plan better honeymoons.

David: One thing on this front on innovation and entrepreneurship in the entrepreneurialism and the travel industry I want to come back to maybe in tech themes is, of course, Airbnb, which is a wholly different approach to this industry but is nonetheless still the travel industry. But first, with that teaser, do you want to jump into acquisition category?

Ben: Yeah, let’s do it. So for me, I have this down as business line. For new listeners of the show, we define that as people, technology, product, business line, asset, or other because we leave ourselves the right to do whatever the hell we want on this show.

David: It's our show.

Ben: Yeah. So in this one, a lot of times we define a product as like, hey, this is a new product you can sell to your existing customers like an Apple would come out with an iPhone after coming out with an iPod. This for me is really something where it’s a new marketplace with new supply, new demand, a new business model and it’s completely separately broken out on the balance sheet. They bought a new business here and they happen to learn a lot from it and really make it the cornerstone of the company and grow from there. But they bought a wholly separate line of business and they kept it pretty separate.

David: Yup. I don’t have much to argue with there. I mean, literally they report it as a separate business line in their financials, so it’s kind of hard to argue with that.

Ben: I figure that's an easy one for me to jump in on.

Drew: I got nothing here.

David: No argument, if our resident grizzled industry veteran agrees. So, moving on. What would have happened otherwise? This is interesting.

Ben: Yeah. What if Expedia had pulled the trigger? That's sort of the obvious one, right? I don’t know. Drew, what do you think about that?

Drew: With deference to my friends at Expedia, I'm not sure they would have done as good a job managing this business as Priceline did.

David: And the good job was just leaving it alone, right?

Drew: Exactly. I mean, this is effectively a VC play. I guess a better question is, why was Glenn Fogel the one who sniffed out this deal? Where are all the great Silicon Valley greatest challengers?

David: Yeah. Greatest VC investor of all time.

Ben: Who was the intermediary that they sold it to? Was it a private equity firm?

David: No. I think I could be wrong in this but I think it actually was a group of private individuals, private investors in Europe that Geert knew.

Ben: Yeah. I mean, it seems like the opportunity talks for them is the real story here. Why let it go? But I think this might be a good time... Drew, when we were preparing for this episode, you mentioned sort of a difference between Expedia’s M&A strategy and Priceline’s M&A strategy, and that Priceline sort of took these risks on early kind of sub-scale businesses that they saw potential in and Expedia tends to buy more established things that have a very reasonable growth trajectory from there that they can add to their portfolio. Does it seem like I'm getting that right? Now I’d love to hear your thoughts on that.

Drew: Yeah. I think that definitely characterized a lot of the deals that made Priceline successful – Active, Booking, Agoda. And again, you saw the strategy we just talked about from Priceline, of buying these businesses and effectively being largely a passive investor, holding them accountable for growth, giving them capital to continue to grow, but not taking too active a role in the management and integration of those businesses. Expedia, by contrast, has built a single dominated scale platform and we should give Expedia its due here. It’s an almost $20 billion business. They do $350 million room nights that Priceline did last year, so it’s a real formidable player in this category. But their approach has been different. They bought Travelocity, they bought Orbitz. They bought Wotif in Australia. They bought these players and their strategy has largely been to say we have a tech platform that is incredibly mature, we put huge investments in and we now want to start to get scale out of it. So they buy effectively these store fronts, replace them with superior economics, superior technology, see some gains in terms of productivity in both clickthrough rate and their ability to monetize it, but have taken a much more active role in the management of the businesses.

Ben: And then another question is, did Booking need a capital infusion from Priceline? Or what if on their own they just sort of continually reinvested their profits in the business and sort of this aggressive Amazon-style way? Is there any way they could have grown to be the scale that they are today? Or would they have sort of lost out in the arms race of competition?

Drew: It sure seems to me like Booking could have done this on its own. Booking didn’t need Priceline to achieve the scale that it did. I think again it’s testament to Glenn’s judgment and acumen in finding the company and seeing the opportunity here. But I think that’s an opportunity that was available to any financial investor.

David: Yeah. At the same, I think this might be a good lead in to tech themes. We’re always just trying to get into tech themes on this show.

Ben: Rename the show.

David: Yeah, “tech themes”. I think that will be pretty boring. This is the thing about marketplaces though and, well –

Drew: You’d have to have more than one tech theme.

David: Yeah. I'm just going to dive in. I mean, to me, this is such a wonderful illustration of everything that is both incredibly challenging and incredibly beautiful about marketplaces which is they’re a total slog to get started. I mean, thinking about those early days bringing all this very fragmented, very disparate supply all across Europe a supply of hotels onto the Booking.com platform and Geert sending up postcards to everybody. You can totally see why Expedia would look at that and say like, “Ugh. That seems hard, and the business model doesn’t seem as good as ours.” But then the thing is, once you get to a certain scale point, and I think this is the value of capital and building marketplaces, is accelerating to get to that scale point, then it tips and then it’s just the defensibility. We’re talking about why you haven’t seen more major companies built in travel online. The defensibility is so great in Booking, like because everybody is on it, on both sides of the marketplace there is no incentive for either side to go anywhere else because the experience isn’t going to be as good.

Ben: Yup, and it really is an argument for consolidation too. We’ve said this before but one of the reasons why we set out to do this show is understand when M&A works and when it doesn’t so that when we’re involved in the early stages of companies, like we can try and figure out how do we steer the ship if the goal is to get acquired by one of these bigger companies, like where can we nicely fit. And it sure seems like marketplace businesses are so well-suited, like whether you combine the business lines or not, you could look at Zillow and Trulia, or more recently and here locally, Rover and DogVacay. When you take a lot of supply and a lot of demand and the exact same value prop, a very similar value prop, and you can consolidate a lot of things onto a single platform and bring these things together, it seems like you take that flywheel that’s already spinning so well, yeah.

David: Drew, you had a counterpoint though.

Drew: Oh, I was going to say I think there is certainly pressure. If you talk to hoteliers, suppliers in the world, they’re not stoked about this marketplace. There’s no hotelier in the world who’s like “OTAs were a good thing.” You can have some sympathy for them. If you look at the stock chart of Hilton versus Priceline over this period of time, you can see why they might not be so excited.

David: Well, I totally get that from Hilton and Marriott’s perspective. But what about the 20-room villa in Romania who had no way of acquiring customers otherwise?

Ben: Or the dog sitter who wasn’t yet dog sitting or the Airbnber who wasn’t yet utilizing that spare bedroom. Maybe I'm making an argument for unlocking value that was previously unlocked due to a lack of ability to find customers in the sharing economy. It’s certainly not as true if you’re commoditizing suppliers who are already running a business.

Drew: You guys are bringing a great point. Another way of framing this is this discussion we’re having around OTAs shows let’s say the challenges of the business model, these kind of legacy hotel brands. Because the perspective of Marriott looks really different than the perspective even of a Marriott franchisee who actually owns their hotel. The Marriott franchisee says “I used to have to pay,” and it’s just a slight digression, you know, the way hotel economics work by and large of the brands is you have a brand like Marriott that is a franchiser and it sells to somebody who owns real estate rights called The Hotel of Marriott and then generates some demand. They’ll take a franchise fee on that, roughly between 6 and 15 percent based on their business. But they’re taking that on al the reservations that happen out of that hotel, not just the ones that got generated by Marriott. And over time, those costs have gone up to the point where may hotel owners are saying, “Wait a minute. It costs as much money to sell through Marriott, my own ‘direct channel’ as it does to go to an OTA.”

David: And Marriott.com is probably not doing much for me these days.

Drew: Exactly.

David: Interesting. Well, I feel like this is still on the marketplaces tech themes, I'm going to take some more air time. Let’s come back to Airbnb now and then HomeAway and others. To my mind, what they and Airbnb far more successfully than anyone else has done is taken this marketplace innovation and unlocked just a huge new amount of supply with it and brought many of the advantages that we were talking about earlier in the show that were I think mostly enjoyed by the demand side by consumers and the OTA model, as you were saying, even with the agency model, a lot of supply is like “ugh”, mixed feelings at best about it. But Airbnb has brought this innovation to a whole new set of supply as well where if I own a home that has an extra bedroom, I'm just thrilled that Airbnb gets me an extra thousand dollars a month, right?

Drew: Totally. I think that's Airbnb’s real innovations category. It's just amazing about that business. But to me, the thing that's truly distinguishing about it is the way they created this whole new class supply, and supply that was really exciting. Like if I go stay in New York, I’d much rather stay in a cool apartment in the East Village.

David: Than the $900 night.

Drew: And near a restaurant and have a kitchen than getting stuck in Time Square. Airbnb made all that possible in a way that wasn’t true in the past.

David: Or the $900 a night Holiday Inn.

Drew: That's right.

David: Geez. Brutal. To me, this acquisition and this whole industry really just is such a good example and pure example of the power and dynamics of marketplaces. That's what I got for tech themes.

Drew: One of the things I was thinking about, and as I kind of tried to put this together and we prepared for this, was what it would take to challenge Booking.com. If you think building this marketplace is about gathering enough demand to make this whole thing work, could you compete with them? So again, today, Booking.com has the advantage of having done this for, what, 20 years. They today generate half a billion room nights and they spend $3.5 billion per year on marketing. Because somebody else could do that. Could you begin to compete with them to generate that level of demand? I guess the potential for the person who I was able to identify who looks like they’re at least making a run at it is Trivago. Today, Trivago is spending I think $800 million a year.

Ben: And they’re Expedia-owned, right?

Drew: Expedia I think has a 40% stake in Trivago. The founder is still part of it. But yeah, it’s part of the Expedia portfolio. But taking the same playbook in the sense of can we get enough demand here to make this a platform that gets some lock-in? But the follow-up question, if you wanted to go spend $3.5 billion a year on marketing, could you do it?

Ben: Absolutely. This is one tech theme I was thinking about too. After talking to sort of a former Expedia marketing person, this person was mentioning that Trivago is like absolutely exceptional at digital marketing and really understanding exactly when to be bidding on Google, understanding exactly how high value that traffic is, how high value that keyword is, it's super high fidelity, and instrumenting it all the way from placing the ad all the way through the end of the transaction and continuing to track that lifetime customer value over time. It seems like the way that you kind of win on this is better and better digital marketing. I think there was actually a lot of articles back around the time of this acquisition that Booking had sort of been incredibly successful because of their mastery of being able to buy keywords on Google, and there’s definitely an opportunity to do better than that now as Google’s tools get more and more sophisticated for this, and I think that it goes to show that Google really does take a tax on e-commerce broadly and with this as an enormous category, like I’d love to see travel as a revenue driver for Google and I think one way that Airbnb is disrupting here and I wonder if somebody else can disrupt in the hotel world rather than just in the kind of specialized Airbnb world is, can you acquire demands of travelers and retain them as your customers without them going back to Google and you having to reacquire them? And Google being the central source of where people go to search for travel stuff all the time.

Drew: I think there’s no doubt that Airbnb has played that role so far and I think to your point a moment ago, David, the fact that they have this unique access to supply has allowed them to take that kind of position. There’s a question of can you do it in the hotels particularly given the fact that it’s relatively commoditized. That hotel inventory now shows up on lots of different channels. But I think one other thing to understand and it’s worth thinking about the consequences for why it works for Booking.com is what allows them to spend that level of scale. Same for Trivago. What allows them to spend at that level of scale isn’t simply the instrumentation or the fact they have $3.5 billion to spend. It’s that they get the conversion. The reason because all these guys look at “what’s my ROI?” And again, part of that is spend, but really, the biggest driver and also commission rate, what’s my take rate around the individual transaction, but the thing that has the greatest delta, the thing that really drives performance, is when somebody came to the site, do they buy? Booking.com’s innovation wasn’t that it looked better. I mean, frankly, you look at it and it’s like, gosh, why are there so many things flashing? The thing is flashing because that’s what gets me to buy.

David: I feel like this is such a powerful concept. Bill Gurley actually has a whole blog post about this about conversion. Especially for marketplace businesses, it is the biggest lever that you have. I mean, we learned this lesson at Rover in that the product that you’re building when you’re at a marketplace company is essentially the matching of supply and demand and the consummation of that match and so your job is to maximize the rate of consummation of that match. And if you don’t realize that, you can start investing in all sorts of things that are not going to be driving your business.

Drew: I guess going back to why did Expedia miss this, in 2002 it wasn’t obvious that this was a marketplace. In 2002 you had big portal tendency deals that drove a lot of traffic. I signed a $10 million deal with Yahoo or with AOL saying I'm going to get this spot and it’s going to be true for the next year. And I'm relatively indifferent, not indifferent but have less pressure around what the performance of any individual session was.

David: Right. because you were just getting that stream of clicks no matter what and you weren’t paying on a variable basis for, right? Got it. Interesting. So, one thing. Actually, Ben, were there any other tech themes you want to cover?

Ben: Yeah, I got one quick one before we move into grading.

David: Great, do that.

Ben: Selfishly, one of the things we do at Pioneer Square Labs is look around at other business models and try and figure out like can this be done in a new space. Something that I think that I've been paying a lot of attention to recently is as this generation shifts toward a more on-demand, less committal life, this agency model makes a ton of sense. The idea that “yeah, I’ll book that stuff” but like if I don’t want to go, I get a refund. My credit card doesn’t get charge until I stay in that hotel. And there’s policies of 24 hour or 48 hours, whatever it’s going to be. But like, you’re afforded a bunch of flexibility and you can sort of plan ahead and then like if you don’t want to do it, you don’t want to do it. So I think a super interesting lens to think about new company creation is what else can you take that people are like hamstrung into committing to right now and all them much more flexibility and change the business model dynamics within the industry to allow them that. Because as we’ve talked about before, the best consumer experience will continue to win.

David: Totally.

Ben: That's what I got for tech themes.

David: Well, if we had some answers, we could start some companies.

Drew: Can I challenge this slightly in this case, Ben?

Ben: Absolutely.

Drew: I don’t think the best consumer experience is what won here. At the very least we need to think broadly about what best consumer experience is. Because it wasn’t like Booking.com had the most attractive, best design website in the sense of UX. Lots of people would say it’s not that attractive. But it was best in the sense that it delivered the most conversions. And the reason it delivered the most conversions was it had the most best inventory.

Ben: Which at least to me, that’s the consumer experience. Like you’re able to get what you want and I think maybe a secondary thing here is probably the lack of commitment to it, but to me, being matched with the correct supply is just a facet of the consumer experience.

Drew: Sure. Point taken.

Ben: So many levers to have it play here.

David: Well, I think it's the same thing. We’re quibbling over the definition of consumer experience but in the same way like I don’t think anybody – apologies to our friends at Facebook and especially LinkedIn, but nobody would argue that those are like the best, most beautifully designed sites, right? But as a consumer of them, you get your experience fulfilled best of what you’re looking for which is I'm looking for professional networking on LinkedIn and social networking on Facebook. Kind of what they look like is almost secondary but it’s what I get out of them.

Ben: So Drew, in thinking through this a little bit more, if consumer experience is the umbrella of things that enable you to win, I think you’re right that being matched with the correct supply is far more important than you’re required to commit.

David: Okay. One last one sort of sidebar I wanted to cover before we grade it and it might inform grading. Drew, I'm super curious. One thing we haven’t really talked about on the episode thus far, we’ve talked about OTAs, we’ve talked about the various flavors of them, we’ve talked about Airbnb, what role does metasearch play in this world? I mean, you were at Kayak for a long time and metasearch sort of takes a wholly different approach. It’s a layer on top, it’s not a marketplace itself. What is that role in the ecosystem here?

Drew: Well, I think it comes down to actually the point we were just talking about with Ben, which is how do I make a decision? How do I find what I want? And what’s the separation between the decision-making process, i.e. I want to stay at this hotel or take this flight on these dates and the transaction process, I'm going to complete this booking. And metasearch, vertical search was an abstraction of, again, that decision-making process. One thing that was really powerful about it that I think has allowed it to grow very quickly is it moved it in its scope. At Kayak it was like we have the most amazing website, it’s two pages long. It’s a front door you ask a question and then it’s a bunch of answers and you can find them when you want and you’re out. Like things moving through a goose was the metaphor they were talking about. I think you talk about –

David: We’re a friendly show here.

Drew: I know you have advertisers though.

David: Appreciate that.

Drew: Trivago did one better, right? You look at Trivago and you’re like, it’s a one-page website. It’s all Javascript, you start typing in, results start to render. There’s so few things that you have to interact with. Again, the benefit of that for them is, well, how quickly can I move from a ____ to a revenue event? All that leads to really effective monetization. Really clear visibility too, right? The point you’re making, Ben, on how well Trivago does at tracking both initial monetization and a ____. All that is possible because all those events happen within the same session. I don’t think I answered your question.

David: No, no, that's great. So I guess for the metasearch layer, it does greatly improve the customer experience and what the metasearch folks have said is we’re not going to monetize at the transaction level, at the marketplace level; we’re going to take essentially a customer acquisition fee from the marketplaces themselves.

Drew: Yeah. So all the kind of mental model, if you will, for meta was Google. We’re going to be a vertical search engine, we’re going to get paid on a CPC basis and we’re going to get paid by the various marketplaces or ecommerce.

David: By the Booking’s and the Orbitz’s and the Expedia’s themselves.

Drew: Those lines have gotten blurry over time and the big driver or I think one of the big drivers that created that was mobile. So on the browser, on a desktop in a browser you had a bunch of windows open, you could do a search, you could then spawn separate windows to complete a transaction. Most websites were pretty well designed from an e-commerce standpoint. You could look at what the conversions were from leads out of a metasearch into an OTA. That broke down especially early on in mobile where folks had poorly designed mobile booking pages and in an app, that process going from one app to the next was convoluted. So the consequence was metasearch engines started to build what they described as “Instant Book”.  Effectively they would allow you to complete a transaction. They would use a book API so they were calling into the OTA or the marketplace to complete the transaction but it happened within their environment.

David: Within the environment.

Ben: And they’re actually getting paid on the transaction fee then rather than just sort of the ad placement?

Drew: Yeah. The reality is those transaction fees is they’ve always been a little bit blurry. A lot of the CPC deals had some kind of performance guarantee or you would get paid on a CPA and you normalize that back to CPCs. So it wasn’t all that different to go from the metasearch-type agreements to the Instant Book type agreements. The thing that was hard about it and I think Instant Book has had a relatively mixed track record. If you’ll get Trip Advisor’s stock performance, their financials you can see the challenges that Instant Book has had. It has had a huge impact on Trip Advisor’s monetization. We played around with it at Room 77. Kayak has done some of it. But it is not taken that much root among metasearch agencies. It has not become that dominant. I think one of the big reasons is it’s actually pretty hard to complete these transactions. You think of sort of all the edge cases that happen when you’re going to complete a booking – the credit card fails, the room is no longer available. All those kinds of issue. Packing gets lost. Like for whatever reason, the transaction doesn’t complete. If you’re doing that in your environment –

David: And it's still a considered purchase for the consumer too, right? I mean you’re spending hundreds of dollars here.

Drew: Exactly. And it’s much harder to deal with those edge cases if it's somebody else’s book API than if it’s happening in your own environment.

David: Interesting. Okay. I feel like we have the full picture now of the online travel industry. Should we grade it?

Ben: Or at least as much as you can get in an hour.

David: Yeah. Online travel industry in one hour or less.

Ben: Well, I don’t think we need to spend a lot of time on grading or at least I certainly don’t. I'm not sure that there was something that was more successful that we’ve done other than NeXT. Like this was a company that was –

David: Whoa. Are you going higher than Instagram?

Ben: I think so.

David: Wow!

Ben: I know. To me, because I look at it this way, like Instagram wasn’t really company saving for Facebook. Instagram has become an incredible boon but would Facebook be completely irrelevant if it weren’t for Instagram? I mean Instagram helped them inform the mobile strategy and like lots more young people interact more per day on Instagram, but in the way that I think that Apple would have been totally hosed without buying NeXT, I think that Priceline may have been totally hosed without buying Booking, and Booking has turned into a gigantic business. Like just comparing Priceline and Expedia, Priceline’s market cap is 92 billion, Expedia’s is about 22.6. Over 2/3 of that 92 billion comes from Booking.com, going from $130 million to responsible for a market cap of 60 billion plus, A+.

David: Wow. You heard it here first. Booking.com - bigger than Instagram. I love it. Wow! I hadn’t thought about that. We’ll let Drew have the last word here but do I think that this is better than Instagram? Yeah, I mean, you made a pretty compelling case there and I haven’t checked the latest Instagram financials. I guess so here’s my knee jerk reaction to that, but I think is the wrong one, is I would say, well, yeah, that's true but like think about market size. Instagram is everybody in the world but then I'm like, wait a minute, travel is everybody in the world too. Or at least a huge portion of it and it is monetizable at a vastly higher rate than social networking apps. So yeah, wow. I don’t know that I'm willing to go better than Instagram but I’ll go at least as good as Instagram. I’m trying to think back through all of our episodes, we have so many at this point, and the ones that are popping to mind I think at stacked rank, NeXT, I mean as we said on that show, it literally was a trillion dollars in revenue that was created by that acquisition. And then I think Instagram and Booking are both of a scale that are pretty incredible. Not a trillion dollars yet but maybe someday.

Drew: What was the purchase price on Instagram?

David: A billion. One billion dollars.

Drew: What do you guys put as the current value of Instagram?

David: Well, when we did the episode which was about two years ago at this point, right, Ben?

Ben: Yup.

David: I think there was an analyst report.

Ben: It was from Citibank.

David: Yeah, from Citibank that valued it at, what, around $35 billion?

Ben: Somewhere in there. I don’t know why I remember the number 19 or 20 but it’s that big.

David: So sort of on the order of that big in a timeframe of call it three years post acquisition and so here we have $60 billion after 10 years. All right, Drew, school us all.

Drew: Well, I'm with Ben on this one. I guess it’s a little bit of home team pride. You’ve got a travel industry guy, of course I got to say it’s the best deal ever.

David: Better than NeXT?

Drew: Okay. I'm hopefully rational as well. But yeah, I think it’s just phenomenal. To think that Jeff Boyd had an 100x increase in the value of Priceline stock as a CEO. That is just breathtaking. Going through the numbers and looking at the level of growth that these guys have been able to achieve over the duration – staggering. And yeah, I guess one of the things, to me, just it’s a little bit humbling. I remember talking to Jeff Boyd at one point in time. I don’t remember when it was –

David: And Jeff was the CEO of Priceline group until, well there was a long history but CEO or chairman of Priceline group until Glenn took over in the beginning of 2017.

Drew: And I remember talking to him, it was like, “What are you guys going to do next year? Talk about your plans. You know, focus on the big industry kind of confines.” It's like, “We’re going to do like we did last year and a little bit more. That's what we’re going to do.”

David: Booking is going to grow 40%.

Drew: That's a pretty good plan. You should keep doing that.

David: Yeah, you should keep doing that. Wow. Well, there we have it. The history of either the second or third best acquisition of all time on the internet. Thanks for joining us, Drew. This has been awesome.

Drew: Guys, thanks for having me. It was a lot of fun.

David: Okay. Real quick. Carve Outs?

Ben: Carve Outs? Sweet. One thing I watched last week that was linked to Daring Fireball and was really awesome to kind of leave on in the background and do some stuff around the apartment was Scott Forstall appearing publicly for the first time to talk about anything related to his old gig at Apple running the iPhone project when he was live at the Computer History Museum a few weeks ago. There’s a Facebook video that we’ll link to here but it starts with an hour of a super interesting panel with some of the folks that worked under Scott on the original iPhone project. This is all sort of commemorating the 10-year anniversary and Scott just telling amazing stories of how the iPhone came to be, a lot of sort of never-been-revealed stuff, personal interactions with Steve, the time when Steve Jobs in his words “saved his life” quite literally from when he was incredibly ill and Steve and some incredible acupuncture sort of saved his life. And it’s really cool. Like if you’re into this podcast or you’re into the Internet History Podcast, Brian McCall’s show, you will really, really like this interview.

David: It's been on my to-watch list and it just sounds amazing. I think this is Scott’s first public appearance.

Ben: Regarding technology, yeah, he I think spoke extremely briefly when I think they won a Tony. He produced a Broadway play.

David: That's right.

Ben: But never about any of this.

David: Since the Apple keynote stage.

Ben: The funniest thing is it looks like he’s wearing the same shirt. They made fun of that but like the dude has a style.

David: Love it. Hey, you got to have a calling card.

Ben: Yup.

David: Mine is so Jenny and Jenny’s dad, my father-in-law Gary and also shout-out to Gary, fan of the show, went to see The Big Sick in movie theaters last weekend and it was great. If you haven’t seen this movie yet, it was both the funniest and the most well done and most touching movie I think I've seen in many, many years. Best movie I've seen since The Force Awakens, for sure.

Ben: Wow. High praise.

David: It deserves it. I think it’s got like a 98 on Rotten Tomatoes or something like that. And it’s great and it’s Kumail Nanjiani – apologies if I butchered that too – who plays Dinesh on Silicon Valley and it’s the mostly true story of him and his wife and how they met and their lives together. It’s wonderful.

Ben: Wow. Cool.

David: Drew, do you want to join in on the fun?

Drew: Sure. I like email newsletters, jetsetter, you know, can’t get away with it. But I’ve been loving Money Stuff from Matt Levine. It’s a little more kind of markets-oriented than pure tech but he is just an incredibly funny writer and super insightful on what’s going on in the markets. A lot of kind of block chain commentary, what’s moving on, going on, people are worried about not being worried enough. He’s got this great segment. So definitely worth checking out.

David: Cool.

Ben: Awesome. Will do. I think that's it. Drew, where can our listeners find you on the internet?

Drew: My Twitter handle is @drewpats. That's probably the best way to track me down.

Ben: Great. Well, thank you so much. We appreciate you coming on the show. It’s a pleasure and I know our listeners will appreciate some actual domain expertise and insight for a change too.

David: Rather than Ben and me speculating wildly.

Drew: Well, thanks for having me, guys.

Ben: Yeah. Thank you to our sponsor Silicon Valley Bank for sponsoring this episode. Listeners, if you are still listening and you are not one of those people that like me really that sort of turns it off at the end of the podcast, please take our survey. Pop open the show notes right now, 5 to 10 minutes. You just finished the podcast, you probably have a couple minutes more of free time. You should do it and hopefully every single one of you, but it can only be one of you, will win a pair of Airpods. So thanks so much guys and have a great day.

David: Thanks everyone. 

Episode 42: Opsware (with special guest Michel Feaster) - Transcript

You can listen to the episode here.

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)


Ben:So we also grade acquisitions. David and I will each give it a grade and our guest can opt to either grade or not, especially since you were part of it.

Michel:I'm happy to grade.

Ben:Yeah? All right. [music] Welcome back to Episode 42 of Acquired, the podcast about technology acquisitions and IPOs. I'm Ben Gilbert.

David:I'm David Rosenthal.

Ben:And we are your hosts. Today we are covering the 2007 acquisition of Opsware by HP. We have with us a fantastic guest, Michel Feaster. So David will give Michel’s full bio in a minute but I want to say I'm personally very, very excited to have Michel with us. A lot of people know the story of the deal from the Opsware side as told in Ben Horowitz’s The Hard Thing About Hard Things. So Michel was the director of products for the division that purchased Opsware and is going to share the story from the HP side of that acquisition today.

So David, can you tell us a little bit about Michel’s background?

David:Yeah. So Michel today is the cofounder and CEO of Usermind which is a unified customer engagement hub based in Seattle and that she founded in 2013. But as Ben was alluding to, a decade ago before Usermind, Michel was working at the opposite end of the tech spectrum from a startup. She was the Director of Product for a division of Hewlett-Packard’s enterprise software business where she led the acquisition of Ben Horowitz and Marc Andreessen’s legendary company Opsware for $1.6 billion. And most fun, flash forward to today, and the tables have turned. Ben Horowitz is now on her board at Usermind on behalf of Andreesen Horowitz, his venture capital firm. And we are honored to have Michel on the show to cover this deal. So thank you for joining us.

Michel:Thanks for having me guys. Really excited.

Ben:And we appreciate it. So before we dive in, we want to mention to new listeners of the show we have got a Slack and we are over 800 strong. That is at Acquired.fm, on the sidebar you can join us in the Slack and talk all things M&A, tech news and any time there is something pretty exciting that happens like the Whole Foods acquisitions, that’s when it really shines and there’s lots of great speculation in there. 

Second is, we love reviews. So you can help us grow the show by leaving a review on Apple Podcasts, that's what we call it now, and tell your friends. 

Our sponsor for this episode is Perkins Coie, the Counsel to Great Companies. We have with us on the phone today, Buddy Arnheim. Buddy is a partner in the Perkins Coie corporate practice focusing on the representation of emerging growth companies, venture capital funds, and other early-stage investors. Buddy is based in Palo Alto and has been the first counsel on companies you have may recognize such as OpenTable, Trulia, Hotel Tonight, and Cloudera. His team at Perkins represents over 450 VC-backed companies. So Buddy, what’s something that listeners of the show may not know about Perkins Coie?

Buddy Anaheim:Folks that have worked with Perkins Coie probably know this. Folks that haven’t come across Perkins Coie may think of us as the Pacific Northwest firm that incorporated Boeing. But we’ve grown quite a bit since those days. We have about 1100 lawyers throughout the United States. We were named the go-to big law firm for Silicon Valley entrepreneurs by JDJournal in 2017 and we’ve been one of the Fortune Magazine’s 100 Best Companies to work for for the last 15 consecutive years.

Ben:Pretty impressive. If you want to learn more about Perkins Coie or reach out to them, you can click the link in the show notes or in the Slack. David, do you want to take us through the acquisition history and facts?

David:Yeah, as always. So as Ben alluded to, we’re going to try and focus mostly on the HP side of the story with Michel because much ink has been spilled about the Opsware side and if you haven’t heard about Opsware, we totally recommend reading The Hard Thing About Hard Things by Ben. It is such a great book. There is also a really great sort of period piece that Wired did in August 2000 right before the tech bubble burst. All about the company and about Ben and Marc Andreessen and this being Marc’s sort of second act after Netscape. So we’ll link to that in the show notes and that provides a really good full history of Opsware. 

But to sort of the stage I'm going to take sort of 5 minutes and do a quick truncated history just so we’re all on the same page and can then dive in with Michel about how HP viewed things. 

So the company that ultimately became Opsware was founded as a different company called Loudcloud and it was started in September 1999 by four people: Marc Andreessen who had been the cofounder and CTO of Netscape and was famously the Internet’s Golden Boy on the cover of Time Magazine among many other press outlets. And Ben Horowitz who was the CEO of Loudcloud and Ben had been a PM for Marc at Netscape. And two other folks – Tim Howes who was the CTO of Netscape’s server division and he was a total expert in sort of internet infrastructure and plumbing. He created LDAP (lightweight directory access protocol) which if you use any sort of internal company directory service or log-on service these days. It’s probably based on that. Pretty amazing. Then the fourth person was a guy named Sik Rhee and Sik I believe had briefly been part of Netscape. But when Netscape got acquired by AOL, he was CTO of the ecommerce platform division within AOL. So that was the division and this becomes important for Loudcloud that when companies back in the day did deals with AOL to be part of the sort of walled garden and sell things via ecommerce through AOL, they needed to spin up sort of microsites to do that quickly and Rhee was kind of in charge of helping them helping Nike or whatnot do that at AOL. 

So the idea for what Loudcloud would be, it actually comes from Sik Rhee, and the idea was basically that it would be AWS before AWS. It was going to be an infrastructure as a service product. The idea was that just like these companies who didn’t have software developers or internet infrastructure teams like Nike or L.L. Bean or whomever needed to spin up website to sell on AOL, they would also need to do that on the broader internet. And why would they go build their own teams to do this, they should just use a service to do the infrastructure for them. 

Ben:David, that was both the human power as a service as well as the actual servers as a service, right?

David:Well, I think it was mostly the servers as a service because remember, the idea of the cloud doesn’t really exist in these days. If you wanted to build a website, the first thing you had to do was go buy a bunch of servers and stick them in the closet somewhere. So that's what Loudcloud was sort of designed to be – your virtual servers.

Michel:By the way that is why they partnered with EDS. So later there is a big transaction I did with those guys and that was for the manned service offerings. So Opsware sold AWS Element and they partnered with EDS to provide a full managed service, and that will be a chapter in the later Element story. 

David:To come. But there’s this great Marc Andreessen quote from the first press briefing that they do about the company and there’s so much buzz around this company before they even launched because these are obviously sort of early, the first generation of tech celebrities and this is their second act. And the quote from Marc is that “It’s like providing the electric power grid and companies can plug in.” I just thought this was so awesome because we’ll also link in the show notes when Jeff Bezos launches AWS later in the mid-2000s, he goes and he talks at Y Combinator and he uses this exact analogy for AWS. I didn’t realize this. I don’t know if Jeff realized this, if he came up with it independently or not, but he is literally using the same analogy the Andreesen used when he was launching Loudcloud. 

Ben:Wow. And so Michel, I mean we’ll get into this in tech themes but clearly AWS, a huge successful business right now. Loudcloud, not a huge successful business then. Obviously, timing is the issue but what was it about the timing? 

Michel:Look at the readiness of the internet for enterprise cloud adoption. And the reason, to me, Bezos is so successful today is, one, development is so much more pervasive. So the number of people who could leverage AWS has exploded. Number two, the costs of starting a company has gone to zero, so the number of targets who would be leveraging something like AWS is so much greater now. And three, I think security and privacy have evolved enough that companies are actually willing to bill. So the number of kind of target enterprises, your deal size, all of these elements around kind of go to market have finally matured to where AWS is not an idea, it’s a business. 

David:There’s another really big of this which is that the whole concept of server virtualization didn’t really exist yet. Like, it sort of existed. The company VMware which listeners may or may not be familiar with but it’s one of the largest enterprise software and infrastructure companies in the world. It’s majority-owned by EMC these days. What they do, they had created a product that was just starting to take off around this time but wasn’t widely used that essentially let you take physical server machines and slice them up into multiple virtual machines. So one box could serve multiple customers essentially, and that was a big key for making something like AWS work because without that, you needed essentially a separate box for everybody. And that was not yet a paradigm that existed in these days.

Ben:Yeah. It feels like that would hamstring Amazon these days. I don’t know. 

Michel:Well, now we’re onto containers, right. That whole technology has emerged. By the way, on our side when we were doing the deal, virtualization is a key reason why HP needed to buy Opsware. So it’s not really just about do you need virtualization to be able to run an effective AWS offering. It’s what problem does that create in IT. So one of the central reasons to me for Opsware’s growth is that as virtualization exploded in the IT infrastructure, the old human way of managing servers and networks and storage couldn’t scale. So one of the single biggest reasons for their success was the exponential growth and complexity that virtualization drove in IT. So if you look at Opsware, as it went from Loudcloud later to become Opsware, its growth from whatever 4-10 million to 80 or 100 million at its exit, virtualization was the technology that drove the majority of their market opportunity, and it was a big factor in our belief that we need to be and own the technology, that this was a key control point in the future of how IT was going to work. 

David:Yeah. Well, we’ll come right back to that. But in the meantime, this isn’t really what Loudcloud is trying to do. They’re trying to be AWS and there’s so much hype. And we’ll just run through really quickly sort of the corporate timeline and fortunately, Ben Horowitz himself made a nice little truncated version in a blog post that we’ll also link to in the show notes, but this is ‘90s bubble era internet at its finest. 

So November 1999, before launching the product, Loudcloud raises $21 million at a $45 million pre-money valuation, and Andy Rachleff at Benchmark led that round. January 2000, so just a couple months later, they raise another $45 million in debt from Morgan Stanley, of all places. They haven’t even launched a product yet. A few months after that, June of 2000, they raised $120 million at a $700 million pre-money valuation. And then things start to go a little rocky but nonetheless, the company sort of perseveres, they do end up going public in March of 2001. They list on the NASDAQ. They raise another $160 million but the valuation goes down from the last private round. Echoes of this happening again today. So they have about a $480 million market cap and then the whole world just blows up the tech world and all of the customers for Loudcloud were these Pets.com era startups and they just go out of business. So there’s essentially no business left for Loudcloud, for the AWS managed service product.

So in August of 2002, as Michel was alluding to, they sell that business to EDS which is Ross Perot’s software company. 

Ben:And what does EDS stand for? Is it Electronic Data Service?

David:Systems. I think it's Electronic Data Systems. They sell that for just over $60 million. But that's the whole business. Like there is no other business within the company and Ben writes about this at length in the book. But what they do have is this technology, this sort of internal tool that they’d created called Opsware. And Tim Howes, the guy who invented LDAP, previously at Netscape, he had created this tool within Loudcloud that was basically an automated way to provision and then deploy and manage all the servers that they had in their data centers. They sort of this idea that like, “okay, Loudcloud isn’t working at all. Let’s get rid of it.” We have this tool, we use it. We think it’s great. Maybe other customers who have big data centers would want to use this. So they essentially completely pivot as a public company after the tech bubble burst and they start down this journey to build an enterprise software company selling data center technology. 

Ben:Michel’s shaking her head over there. 


Ben:What’s going through your head right now? 

Michel:That's an almost impossible task. I obviously got to know Ben much later in his life but it’s hard enough to build. So think about how hard it is to build shrink wrap software that you’re going to sell and install at a customer when you know you’re going to do it. And this is before SaaS, right? So his stuff was all on-prem and they had to take basically take tooling that was built for internal ops people to manage customer environments and turn it into a shrink wrap product. So you just think about like feasibility of stuff you would build for like internal use versus the UI for customers and the level of complexity you tolerate. So just the amount of heroic effort that it must have taken to get that product to be a real product, I think pretty huge. 

On the flip side, if you think about it, they built something that was ahead of its time because their business was so complex. To my earlier point as enterprises start to adopt virtualization, they start needing something that looks very much like what they built for their own internal management. So is it crazy or genius? I don’t know. And I can’t even imagine doing that public, like that would be incredibly hard as a pivot if you’re a private, venture-backed company. Never mind you’re on the stock exchange. 

Ben:Right, right. 

David:Just for context – oh, go ahead, Ben.

Ben:We’ll get into tech themes later but thinking about my job all day and working on an early stage idea and doing customer validation, you have to always find a proxy for your customer and figure out would someone use this, is this feature useful, try and get inside their head and be an intuit what the customer might want. But Michel you said on the flip side, like they were there own customer and they were yours ahead so they were kind of building something that was going to be valuable a few years in the future once all the dust settled with absolute perfect information on what the necessary components of the thing were. 

Michel:The perfect scenario there is they had the persona 100 percent right. They were building tooling for server admins who were needing to manage environments at scale with multiple applications in there. That's the way IT began to look five years after they started selling that software. So you’re dead right. Probably their biggest advantage was they were ahead in kind of the kind of software operation they were building and they had the person a thousand percent dialed in because they had lived that pain all day every day trying to run that service offering. So with that challenges came huge advantages that they were able to parlay into an incredible software company. 

David:I'm wondering given that you both saw this when you acquired the company from the outside but now, you’re a founder and a CEO of an enterprise company. When you founded Usermind in 2013, how long did it take you and how long did you work on building the product before you felt that it was ready to shift for customers? You knew the customer persona when you started, but just so we have context and our listeners have context, like how hard is this task? 

Michel:Oh, it's really hard. We spent four months interviewing. So for me just to think about and define the persona, the use cases, the product, four months of interviews, probably three hundred interviews just to kind of get to set requirements. Then we went through multiple iterations. It probably took us 2 ½ years to go from an alpha or prototype alpha beta to launch the software publicly and begin selling it. And look, necessity is the mother of invention so they had to do what they were doing or fail, and I'm sure that gritty determination was another big part of that later success. But that's a pretty hard turn to make, to take that software and figure out how to package it up. I would imagine a lot of their challenges were UI related, where how do we now expose this tremendous tooling and IP into an application that users can use who are not Opsware employees. 

And oddly enough, by the way, I never really talked to Ben about that part of their history. I never spent a lot of time talking about this particular moment in time. 

David:Well, what’s funny is you’d imagine, I think if I went through this, I’d probably never want to talk about it again. But Ben went and wrote a whole book about it.

Michel:Yeah, and thank God. I feel like he’s the first... not investor but first CEO who essentially exposed the myth that it’s all perfect all the time and kind of gave I think CEOs and leaders permission to talk about all of the hard things that really make or what he calls the struggle. I remember when I was going to found and he told me “your hardest challenge is going to be managing your own psychology.” And he’s dead right. To me, his book gives people permission to talk about what that’s really like.

Ben:Yeah. I never attributed to that but you’re right, the last few years it just seemed like the climate of okayness to talk about these things has dramatically increased. 

Michel:Yeah. I think he was a big part of it. I wasn’t an entrepreneur. Ben is the person who changed my life and kind of got me out of Mercury and into startups. But I think at least in my mind that permission from someone like him to talk about the truth, it's a great gift 

David:You mentioned Mercury. Just for context for our listeners. So, the way you came to HP was you had been at Mercury Interactive, which HP had acquired shortly before the Opsware acquisition. 

Michel:Yeah. Sad day. 

David:Sad day when HP acquired Mercury? 

Michel:Yeah. I love mercury. All acquisitions are hard on all sides. 

David:So what was Mercury and how did you come there and what ended up being the fit that you saw between what Opsware became and Mercury? 

Michel:Well, so one, I was at Mercury for almost eight years. I was originally in the pre-sales organization and for people who don’t know, it’s like technical sales. You’re going out installing software and you’re kind of the technical half of the selling motion. I'm in an enterprise software company. I joined Mercury, probably about 200 people or 250 employees and I stayed through 3000 through almost a billion in revenue, so it was an incredible experience. 

Ben:Wow. I bet.

Michel:Really amazing. I spent half my time there in the field in New England and in fact, started out really just POC-ing and selling technology. I was very blessed. As the company scaled, I ended up owning more strategic accounts from a technical pre-sales perspective. So when you’re selling to GE or Fidelity, they’ll say “No. We want a three-year roadmap with Mercury. We want to talk about how to partner strategically.” So I started to work very closely with a product organization and eventually moved out to California and took my first product role. I was very blessed. I was the second product manager of a product called LoadRunner which when I took over that product was already a $250 million business. It had 65 percent market share. Customers loved it, the product worked. So I learned product management or how to think about product strategy taking over like an incredibly successful business and so I was given such freedom to put it in tele sales, put it in partners, innovate on the product. And I can’t imagine a better school of product management. I rotated around. I basically managed all pieces of the testing business. And then when we got acquired by HP, my boss called me and said, “Hey, there’s this really broken business.” So this is now the time when virtualization is just exploding in the enterprise. Opsware probably is the market leader and data center automation competing with BladeLogic at IBM. HP had a business.

David:This is kind of 5 years after the pivot. Or in 2007 now, virtualization is finally a thing.

Michel:It is. And when you look at that, what that really means is that all these kind of human methods, the manual ways of now automating data center management end to end start to break down essentially. You can’t scale human beings indefinitely. So there’s this incredible froth and excitement over this automation market and HP had acquired a couple of companies. They acquired a company called Radia. They had acquired a company which did kind of like Opsware server automation but they did client desktop management as well. And they acquired a storage product called AppIQ. But really, after spending probably $100 million, having 200 engineers on this problem, we’re fifth in the market. So you’ve all said to me, my boss (the head of products at Mercury) said, “Hey, there’s a lot of heat in the sales organization about this. Customers want a solution from HP and we’re losing a lot of deals. You’re kind of my glass breaker. You want to go in there and figure it out and it will be a great opportunity for you, a great exposure.” So that's kind of how I got in a position where I needed to think through a strategy which ultimately led to acquiring Opsware. 

Ben:I might be skipping ahead here a little bit and then David can take us back but this is a perfect tee-up for how did you do that build versus buy? How did you do that calculation? How was that done in a company like that? 

Michel:It was kind of interesting. So I took over and agreed to do it, took over the business and two weeks later we had this – I don’t even know what we call it, a quarterly business review (QBR) and I'm supposed to be updating the Head of Software, Tom Hogan, and Deb, and kind of all the execs of software on our strategy. I just took over. Like, I don’t know what strategy is. So I just kind of went back to first principles. So to me, first principles are what our users want do and what’s happening in the market. So I kind of interviewed everybody in the team and I talked with the analyst and I got some basic data. And the math to me was incredibly clear. So when I looked at it, we had 200 engineers on something where we were generating whatever, 20 million in revenue. We’re fifth in the market and when I looked at the first 3 players, so to me, there’s either emerging markets or consolidating markets and it’s important to know what market you’re in. When I looked at that, I thought, “Well, gosh.” Between Opsware (market leader), Blade Logic (second player), IBM who had done an acquisition, 80 percent of the market is in the hands of three vendors. Well, that's not an emerging market. That’s a consolidating market. 

So that's kind of question 1 is where are we at in the market evolution. And question 2 is who are we as a company. There are companies who can disrupt a market that’s consolidated. Mercury could have done it if we wanted to. But my point of view is that HP at the time and still by the way and probably is, is a channel company. And what they really have is just like IBM as an incredible channel and what they’re great at is selling good software to companies who trust them and delivering it. What they’re not good at is building new things from scratch. So the second part of my calculus was Sun Tzu says if you know yourself and you know the enemy, you’ll be victorious in a thousand battles.  

David:We’re big fans of Sun Tzu on this podcast. 

Michel:I'm a huge fan. So my second rationale was in a consolidated market, there is no path for a company like HP to build its way to victory. So you’re only left with buy or exit the market. 

Ben:And you think if it was in an emerging market, then HP would have had a chance at building their own but still typically worse than a startup.

Michel:It would have been almost impossible for that to happen but yes, I mean in theory, we could have had a chance and you probably would have taken a different strategy in that context, right? So I actually was given a very simple problem. There was nothing really complex about answering that question. There’s more to it but that's essentially the math. Even more if you looked at it in the context of the whole portfolio, why would you invest so much engineering for so little return? Because the other part about software which we all understand in valuation is that the only players that make any money are the #1 or #2 player in the market. So even if there was a path for HP to become from 5 to 4, or take out IBM in 5 to 3, profitability goes to the winner. And so you lose money indefinitely on a software business unless you become the dominant player and then you make insane profit. To me, if there’s no path to #1 or #2 for you based on who you are, that's really what you need to look at to buy a solution. 

So that was really – I think I presented five slides, it was very concrete. I also, by the way, spent a bunch of time interviewing sales people and trying to understand how important this was, meaning how often was it coming up in deals, what was the channel relevance. Because the other piece of it is if we did a deal, can we monetize? Are we talking to the people who’d buy it? Do we feel like we could have gotten that money that went to Opsware, IBM. And the was maybe the last piece of the calculus was the channel fit was very high. So HP at the time had many brands, Openview being one of the most famous ones that we were selling to the operations teams. So we had a very experienced channel selling to the same buyer that would be buying Opsware or buying BladeLogic. When you really step back and look at that math, it’s pretty obvious that it has to be an M&A scenario or you should shut the business down. So that was phase one.

Ben:But you probably did enough calculus on what does this market look like in 5 or 10 years where it was like we can’t afford to not play in this market. 

Michel:Yeah, I mean that's all the obvious math. I guess that was implied in my head. I think probably if that didn’t make sense, HP wouldn’t have already been in this space, so maybe that's why I didn’t reference it. 

David:This was the future of the data center, right? I mean virtualization is now, I mean, I don’t know that there’s any data center probably in the world that doesn’t at least have some degree of virtualization now. 

Michel:Oh, yeah. And oh by the way, now it’s become containerization. So if you have won this battle, in theory you have a very strategic control point. So to me that goes to the now you’re in the second question which is, okay, if it’s either go buy the winner or shut your business down, you’ve asked the next question which is, is this strategic land? Do we have to own this land? Is it a strategic control point to owning the future disruption of the enterprise or is it strategic to my buyer the point where if I don’t have this, I undermine other businesses?

David:And the buyer being the end customer here that you’re selling to, right?

Michel:This IT operations person, yeah. And so you guys have already made the argument. It’s pretty clear that our actual Uber theory at the time was that for IT operations folks, automation and monitoring were ultimately converged. So the winning vendor for IT operations wasn’t just the winning vendor who had HP OpenView. But it was the one who had the best automation and the best monitoring. When you think about it at that level, by the way then your competitors are very few people. You’re competing with HP and with the BMC NCA. And so the number of people who could actually if that's really the winning strategy in IT operations, how many people are positioned well to compete with us. So we really thought that if we did this deal, it was us and BMC competing to dominate IT operations. In light of that you can see why the buy decision became very clear, that we felt it was strategic land not just because of the immediate opportunity around virtualization and kind of the core automation problem but our hypothesis that it would become a converged solution and that that would actually strengthen our already dominant OpenView business, right? And that it would be a 1 plus 1 is 3 in the broader IT operations business. So you can see what drove from our point of view we called it a coveted asset. We felt that Opsware would be not just breaking the Opsware business but it would be affecting a much larger existing business within HP. 

David:So you do end up buying it in July 2007 for $1.6 billion. And after the pivot 5 years earlier in the public markets, the public market pivot, what then became Opsware was trading for $28 million of market cap which was $40 million less than the amount of cash that they had in the bank. So they had 60 or 70 million of cash in the bank and they’re trading for $28 million. So 5 years later, incredible turnaround and achieve an exit that's 50 times that. What was it like after you bought them though? From an integration process and a culture, this was a team that had been through the fire twice. 

Ben:Absolutely. I want to know that. Michel, the one thing I’ve been really withholding back from asking is, okay, so you make this presentation and it’s five slides and you make a decision, like what logistically happens after that? You shoot an email to like Ben at Opsware? How does that happen?

Michel:So there’s actually two interesting things that happens, if you don’t mind, before we answer the integration. So the process, obviously the executives have to kind of come to some consensus that they agree to that. There was quite a lot of discussion that I wasn’t part of but where the head of software talked to his head of sales and so kind of validating, “hey, this is important. Hey, we’re seeing them in all the deals.” So the executives needed to go and think about it as well as kind of validate the data I put forth to them about how important this was going to be. So it took some time for us to get kind of organizational alignment on the state of the market and how key this could be. Honestly, it was not that controversial, I think. It was really clear that we needed something that customers wanted us to have a product. The interesting discussion was then, who do you buy? So kind of before you get to the buying Opsware, there was an alternate vendor.

David:BladeLogic, right?

Michel:BladeLogic. Right, yeah.

David:Which BMC did buy. 

Michel:Which BMC did buy, right. So the interesting thing about that is you don’t email. So what happened is someone from corp dev was assigned to us. So Sandeep Johri at the time was running corporate development and he kind of took ownership of the project on the corp dev side. I wasn’t actually involved in that, not in that piece of it but I wasn’t on all the email chains where they’re emailing Ben. I was in most of the meetings. I did all the technical due diligence so you kind of start these threads and we ran our threads in parallel, so we were talking to both Opsware and BladeLogic. And that involved financial due diligence, customer reviews, technical diligence. It was pretty fascinating. In fact, once we had decided our vendor, we were onsite during their sales kickoff which was a little-known fact and I in fact couldn’t leave the room, so everybody else is allowed to leave but there were so many Mercury people at Opsware that people were worried that if I left, everyone would know who I was. So there’s quite a lot of drama to that. But look, the net of why Opsware versus BladeLogic, to me it boiled down to what do you need to buy and how many acquisitions can we execute. So, there’s kind of a little-known wrinkle here which is why they started as a server automation company, that was the LoudCloud heritage. Ben’s vision was to automate the data center. So they did acquisitions to acquire a runbook automation technology from a company called iConclude that was based in Seattle actually. They bought a network automation company. I actually believe that one was based in Seattle as well. So they made a couple acquisitions to extend their product line from server automation to what they call data center automation. And our theory was actually slightly bigger than that as we felt that what customers wanted to do was deploy services end to end. So the winning vendor would be executing a product strategy to bring desktop, server, network, storage, all of the automation elements into a suite to automate application deployment so that servers on some level are just one tiny piece of an end-to-end IT service. So that was the strategy we were executing. When you look at that, we had a client product already at HP and we had a storage product from these acquisitions we had. 

So really there was a lot of differences from a market share perspective. Clearly Opsware was ahead of BladeLogic and that's very attractive. You kind of de facto always want to buy the market leader. However, at the time, BladeLogic had a better product than Opsware, so that is the downside of this kind of LoudCloud. And I would say better product in the sense of usability. So where they lost deals, it was on usability. Where they had one deals, it was an enterprise scale. So there were product implications to this kind of pivot that they did. 

David:To preview tech themes a little bit, I mean this is something that for listeners that aren’t as familiar with enterprise technology, it is just a hard thing initially to get your mind around. Steve Jobs talked about this that in the enterprise, it’s not always the best product that wins. Opsware was the market leader but as you’re saying, they didn’t have the best product. They had the best sales motion.

Michel: Yeah, and at least in server automation. So their strategy was to basically move to the suite motion. So they had the best suite. BladeLogic did not have other products. They had partnerships to solve that problem. So if Opsware could move the buying criteria to being data center automation, they won, because it isn’t just head-to-head product to product. So our assessment was, number one, we wanted to buy the market leader and that having the first mover in our channel, best current position in what we thought was one of the best channels in the world is the best combination. But the second piece of math for us was that if we had gone after BladeLogic, we would have had to do three additional acquisitions and we felt that the risk, even though if it would have been cheaper, we thought that actually the likelihood of our ability to successful acquire four companies was significantly less than one. If you look at big companies buying small companies, in many cases the medium-sized ones do the best. They’re big enough that they can be put in a channel and it works. In many cases these little technology tuck-ins, a $10 million acquisition is harder to make work than a billion-dollar acquisition because there’s not a critical mass of people and ideas to teach the rest of the company how to sell.

Ben:Oh wow.

Michel:So the two pieces for us on Opsware were, I guess three. Strategic alignment, they had the full suite, they were the market leader. And even if they had some product deficiencies, we felt that we were much more likely to be able to execute that successfully than BladeLogic plus three others. So that's kind of the math that led to the end of us saying our preference, our top partner, our top target would be Opsware versus BladeLogic. And we continue talking to BladeLogic to the end. So if we had lost Opsware to BMC or to whomever, we would have had a fallback plan. But we had a clear preference and paid a premium for it, frankly.

David:So now I want to jump to the culture and the people piece. That is bulletproof logic there. But the Hard Thing About Hard Things or you listen to Ben or you look at Andreessen Horowitz and the first thing that comes to mind is not HP. What was it like integrating this team? 

Michel:Interesting. So one, if you’ve read the book, Ben has a management technique called Freaky Friday. So I thought, hey, I'm going to run the integration and they’re just going to give me some special projects and send me off in the sunset. I didn’t expect to have product ownership at that point. So ben actually swapped me and his head of product at the time, Eric Vishria. So Eric took over ITSM. Eric is now at Benchmark Capital as a VC and founded his own company kind of in between his stint at HP and joining Benchmark. But Eric joined the ITSM team and took it over. And Frank Chen who was the product management half of that partnership–

David:Who is now at Andreessen Horowitz.

Michel:And is now at Andreessen Horowitz, moved into engineering to help, under Jason Rosenthal who was the head of engineering there at the time. So Ben gave me a product and that was incredible. So he calls it Freaky Friday where he swaps executives. 

David:Oh, like the Jamie Lee Curtis movie. 

Michel:Yeah, that's one of his management techniques that he wrote about. And I worked directly for him. So that was pretty amazing as an opportunity and experience. I think a part of why it worked is that I wasn’t HP. I was a Mercury person where the DNA is much closer to Opsware. By the way, like that silly sales kickoff story, there were many Mercury people at HP. Mercury was a very Israeli company. Very, very aggressive. Very direct. We were very customer-focused and winning was incredibly important. So a lot of external values that I think naturally close to the Opsware teams.

So I think one piece of it was he put someone in charge of the integration who had the same cultural values as his own team and I think that made things easier. But for sure there’s cultural friction. As an example, we’re going through the integration, the formal integration process and I remember being on the phone with the IT organization and the IT organization is insisting that we have to shut down all these nonapproved apps that Opsware has and one of the nonapproved apps – I’ll give you two that are just outrageous. One of them happened to be the licensed key generator for all of the Opsware software and we had to shut it off at the time of acquisition according to IT. And I'm like, “Someone help me understand why we would spend $1.6 billion and then basically be unable to sell and turn on any of the software. Or the other one was like –

Ben:Wait, there was no like grace period of like we should spend something else so that –

Michel:No. Day one. So you’re in this like six-month whatever it was, four-month. I don’t even remember. It was kind of like dog years. You’re in this integration which is super intense but you have this deadline. And IT had very strict objectives. I mean, Mark Currin was running HP at the time, so it was Mark Currin’s HP. Second, they had a source control standard within the company and of course they were like, well, you’d have to migrate all the source control and source code into this new...

David:This is pre GitHub.

Michel:Yeah. And as you know, in that time, that was just almost impossible. So there was a lot of these kind of weird operational hurdles that I wouldn’t have anticipated. That's kind of a whole class of problem that you have to deal with. Again, I feel like I was very lucky because I was kind of a liaison. I probably absorbed a lot of that weird cultural friction for those guys in that sense, at least during the integration. And actually, at the time Scott Cooper was my partner on the Opsware side so he’s now I guess the COO running all the operating arm of Andreessen Horowitz. And he’s a great partner on the Opsware side. For me, working with them was very easy and a lot of my job was basically trying to prevent the big mechanism of HP from making unnatural things happen. But once we had them integrated, I think then it was a lot more interesting so you kind of get this middle period where you’re dealing with all the organizational administrivia that’s frustrating. I think one thing we did well in that period was we took market share so we kind of really sold the heck out of Opsware in that period and gained a pretty good advantage over BladeLogic because at the time, BMC hadn’t yet announced their deal with Blade. 

And then was we formally integrated them, we had all of the challenges you can imagine. So the software, the sales organization, you start to break up the teams so instead of being Opsware now, engineering is part of Ben’s organization, so Ben took over products and engineering for HP software. So on some level that’s a little safe. The sales organization got put under some of the sales leaders as overlays and to be honest, that’s an area where if I look back, gosh, I wish we had done a better job. So the good news is we had these experts, these black belts, and Opsware was global. So we immediately got traction globally. But, you know, overlays are a hard thing to make work, I feel like.

Ben:You say overlays as in there’s HP management on top of each of them.

Michel:Oh, no. Yeah, sorry. Sales overlay. So generally speaking, when you put a new product that's hard to sell, there’s a lot of IP in how to sell it. And so you take the sales organization of Opsware and who used to just sell Opsware and now they’re basically what we call overlays. They work with the HP people because the HP people already own all those accounts and they sell this huge portfolio software but they don’t know Opsware. So you have this kind of digestion period where you try and disseminate the expertise of the acquirer company into your sales organization and eventually you want the motion to be that's fully absorbed and everybody’s fully trained and you can sell. But the biggest question is how do you train and enable that sales organization to be even half as effective as an Opsware person was in objections and challenges and competitive landscape and so forth. That presents its own whole set of challenges.

David:I was going to say I think this is a big thing for listeners to understand. It’s easy to look at this from the outside and say, okay, like enterprise is about sales channels and sales motions, like I sort of get what that means. But like this is it in practice. The Opsware sales team was sort of a finely tuned machine to sell data center, automation and management. But the HP sales team is selling all sorts of things, a whole portfolio of everything you can imagine to CIOs at companies and so now Opsware is going to be just a small piece of that portfolio and so you need the HP sales team to digest that and understand how to sell Opsware best. But it's not just about selling Opsware; it’s about selling everything. 

Michel:Yeah. So you have a huge enablement challenge and I love that. I ran the product management and product marketing organization for the combined business, what we ended up calling BSA. So it was business service automation. We kind of did away with the DCA term. But it was a phenomenal challenge. We did so much training. I actually flew in the year after that acquisition. I think I flew 350,000 miles worldwide, visiting customers, doing deals, trading reps. It was pretty phenomenal and we saw huge growth. It’s been a long time for me. It’s been a decade but I don’t remember. I think by the time I left we had seen a 350 percent growth in the business. So from that perspective, it's at least a huge early down payment of success on your vision of kind of the value of that technology. 

Ben:We’ve got a format to this show that at some point we’ll move here into categorization, but I'm curious looking back on it all where the state of data centers are today and with the rise of cloud services and the major players being Google, Amazon, Microsoft. You can make arguments about that but you don’t often hear HP thrown around in there. What do you think happened in the last decade from the world of data center automation and the business center automation? 

Michel:Business services automation.

Ben:Business service automation into the world that we have today and why isn’t HP one of those big three or big four?

Michel:Yeah, interesting. Well, I mean I look at the natural successors of Opsware and I think of companies like Puppet and Chef. 

Ben:By the way, how fascinating. One’s local in Seattle here but they’re both going to be public companies. I don’t remember if Puppet already filed but it’s pretty clear that those companies are on their way. So the inheritors of the problem in the market opportunity are those companies and in fact it will be very interesting to see whether dockerization brings a new generation, a third generation or whether dockerization just accelerates Chef and Puppet, they’re able to capitalize on that motion. But why not HP? Look, it’s very hard for big companies to innovate and here’s the reason why. Innovation, number one, is a people thing. So you have to have a really high quality of thought. That's all people. And at least at the time I was at HP, it was interesting. Hurd had a very manufacturing mindset and manufacturing companies look at people as very interchangeable. Software companies have this idea of the 10x-er where the 10x developer can do things that no one else can do and the 10x product person can see things no one else can see and it’s really true. That there isn’t a scaleableness to the way software works inherently like you can’t replace Steve Jobs with a hundred other people and get the same work that Steve Jobs did. It just doesn’t work that way. So when you look at kind of our software organization or a software business, one, you need to retain those top people I think big organizations have just an incredibly hard time doing it because of a culture mismatch. My level of patience for the HP culture was very low. By the way, my culture fit with them was very low. I swear too much for HP for example. But you get that like weird DNA mismatch. That’s kind of one big challenge. I think the other big challenge is that institutionally, you need courage. So I actually thing Mercury is an example. There are big software companies that can innovate and cannot have a disruption destroy their business but take advantage of it. Maybe Chef and Puppet will as an example. But Mercury went from zero to 3000 people, zero to a billion. So you can do it. 

And I think the second thing required besides these 10x-ers and your key roles and product and engineering and sales is you need the courage to basically bet before the data is obvious. So you’re an ops person in unusual situation where the product – by the way, their vision was whatever, 10 years ahead of its time really, so timing might have been a problem for them. But the vision’s dead on and the product was close enough that they could go monetize it and they ended up, their timing was right on virtualization. So talk about the confluence of events. I think when you’re in a big company, the second challenge that's really hard is that disruptions often sneak up on you. So if you’re HP and you own Opsware and you’ve won, do you really have anyone in the company who can feel that docker is coming and know that existentially docker is a threat to your control? Or whatever it was, I don’t know. I wasn’t close enough to the business around the Chef and Puppet time frame. Yeah, actually probably it was dev ops. So the fact that development and ops were converging represents an existential threat to your business. 

So the second challenge that big company has is not only do you have the right person but that person would see that threat coming and be able to mobilize the leaders to move. And so, in a big company you need the geniuses, you need them to see far like with almost no data, and you need leadership who will bet based on that. And that's, I mean, to be honest, most executives in big companies are used to waiting until the entire PowerPoint deck is 50 slides and all the data is there and that the decision is safe and you have Microsoft not under Satya but maybe that's Ballmer’s Microsoft. And you miss the entire market. So I think that's probably why it’s not HP and it is Puppet because it’s much more than those. The software is the outcome or the people and the process the leadership use, right? And once that falls apart, it’s almost impossible to replicate. My two cents.

David:Oh, man. I'm just itching here. This is going to fit in so perfectly with my tech theme. Should we move along to get there?  I definitely want to come back and talk about what it’s like now having Ben on your board at Usermind. But let’s finish out Opsware first. 

So acquisition category. For me, this seems pretty clear. It's a product that you bought to put into the HP sales channel. So to me, this is a product acquisition. 

Ben:Yeah, and I’ve been torn between product and business line. And we sort of defined business line as self-sustaining, independently functioning product that comes with sales and vision that just may not be independently broken out to shareholders as a separate line item but basically functions as its own independent business. It seems like after hearing you talk and after David asserting product, I'm closer to product now and I'm thinking there is much tighter integration much more quickly and it was not really an independent business. But we’d love to hear your thoughts on that. 

Michel:Yeah. No, not really. I mean Ben took over the whole HP software business. He became the head under Tom Hogan of product and engineering. And we definitely had the Opsware organization separate for a short period of time but no, the integration was incredibly rapid. And the purpose of that was to inject the DNA into a broader organization. So there was a larger transformation happening within HP software at the time. The acquisition of Mercury was I think the first and then Opsware and they did others after I left. Autonomy not being a great example. But there was a bunch and there was an Uber strategy, an overarching strategy there that they were trying to transform the culture and transform the software organization. So the integration strategy was very much driven by this overarching vision that they had about kind of bringing in a bunch of fresh DNA. So no, it was not run as a standalone business except for the period during the integration when that's required.

Ben:Cool. David, go for it.

David:I was going to say then we have What Would Have Happened Otherwise? I think we probably covered that pretty well with the discussion of BMC and Blade Logic. 

Ben:Yeah, I have one thing to sort of posit on that. And Michel, if you guys have made the decision that you know what, we’re not going to buy, we’re not going to build, we’re just going to be done in this market, would HP be in a significantly different position today?

Michel:You know, I’ve been gone so long, it’s a very, very hard question to answer. Look, I mean, I guess if I had been there and the answer was we didn’t want to do Opsware or Blade, then I think I would have proposed that we take all the engineers, I would shut down the DCA business and I would have proposed essentially shooting for the next product and taking that engineering team and building a converged automation and monitoring product with every engineer from the team, and basically give up the land for the current iteration and wait for the next disruption and bet that we’d be on time. I don’t know if that would have happened or if it would have been successful but I believe I wouldn’t have gone down without a fight. I would have fought for what I felt was the right thing for the company. 

Ben:Right. It’s a very interesting tech theme where we’ve seen this multiple times with multiple companies but when you miss one hill it really gives you an opportunity to see the world from a different perspective and be better at taking the next hill and be better at targeting exactly what customers want, and there’s a little bit of desperation there. I mean, Apple and the iPhone. There’s tons of examples of...

Michel:Mother of invention. 

Ben:Yeah. We missed this war or we missed the battle but hopefully we hit the next one. 

David:Yeah. I mean, LoudCloud into Opsware. Shall we jump into tech themes? 

Ben:Yeah, yeah. 

David:Ben, you want to kick it off? 

Ben:That was the main one that I wanted to point out, so why don’t you go for it.

David:Okay. Well, I just loved it. I was grinning ear to ear, Michel, when you were talking about timing and management. And for me, what this story just illustrates so well is like the absolutely critical role of timing in technology, both consumer and enterprise. I mean LoudCloud was 100 percent the right product. It was AWS, before AWS, and AWS is one of the probably top three biggest and most important products in technology today. But the timing was wrong. And I can’t remember where I heard this but I think Sequoia (the venture capital firm) did a study a number of years ago about what sort of the most important factor for their investment partners in how the quality of their decision-making and the quality of their investments, and they concluded that it was timing. It was getting the timing right in a market. So that was what I had down as my theme for this episode but I think what you said, there’s more to it than that, and that's that the role of talent in technology both from a product and management standpoint, is managing that timing. Like it would have been so easy at LoudCloud to say like, “Well, we got the timing wrong. We’re done.” But what Ben and Marc were able to do was say “We got the timing wrong but we’re going to get the timing right on this other piece of it and we’re going to pivot into that.” And I think that’s what like talking about 10x folks in tech, it’s having that vision and being able to manage timing in a market that’s really what it comes down to I think both in consumer and enterprise. 

Michel:Yeah. Look, I think timing is it’s the one law you just don’t control. It’s interesting. I think Marc Andreessen talks about it. Good market, bad team - they do alright. Terrible market, great team - you’re kind of screwed. And so like, what trumps what? You’ve got kind of is the idea good enough, how big is the market, timing, and then people. So I always say like, what’s the why? What’s the idea? What problem are you solving why? The second question is, why now? Why is it inevitable now that this idea should matter or be more relevant or actually be a business. And the third part is where team is in. It’s like what’s the likelihood you have to execute into that. Then it’s interesting. I think on the people front if you go into Ben Horowitz’s office and Andreessen, he has people on the wall, pictures of people. And it’s scientists on one wall and boxers on the other. And we’re both big boxing fans. But he would summarize it this way, which he says entrepreneurship is the intersection of intellect and courage. So I think it’s not just seeing that the thing is happening. It’s having the courage to fight for the deal on the case of an acquisition or fight for the strategy or fight for your life in the company if you’re failing. I think that can’t be underestimated, is the level of grit and kind of I call it a little bit irrationality that's required in that human capital to be successful. 

Ben:Wow. I love that phrase.

David:It was that, right, that took a negative equity value public company at the time of the pivot to a $1.6 billion acquisition. 

Michel:Yeah. I think Ben is a great man, there’s no question about that. And one of the most genuinely humble and nice people I’ve ever met in my life which is just doubly incredible. 

David:That's awesome. All right, should we grade this? 

Ben:Yeah. So Michel, we were talking before the show and you said, “Yes, indeed I will help grade.” So I'm curious looking back on this and sort of taking yourself out of the equation, how did it go? 

Michel:I would probably give it a B. I think we were able to get a huge revenue boost. We essentially accelerated the market dominance of Opsware. I think the reason I wouldn’t give it an A is I don’t think we saw the strategic long-term vision come to fruition the way it certainly could have and I think the biggest difference is people. You lose Ben, you lose me, you lose Marc Cranney. Those are the people who would have made that next wave of value creation happen. So that's my perspective. Although I guess maybe it's an A+ in the sense that if we hadn’t acquired Opsware, Marc and Ben wouldn’t have founded Andreessen Horowitz.

David:Wouldn’t have founded Usermind.

Michel:And I think they’ve disrupted the Valley. So, maybe it’s an A from that point of view.

David:David has pulled that card before where the actual financial outcome for the company was something but the goodness for the world was something else.

Michel:And maybe I meant B from HP’s perspective. 

Ben:Yeah, and that is how we grade on the show typically, is how good of a decision was it for the acquirer to make a decision. And David, I think the time when you pulled that was PayPal mafia. 

David: Yeah. I think it's completely relevant here again. I mean, there is an Opsware mafia. You talked about Eric at Benchmark and practically the whole Andreessen Horowitz team or at least the initial team. 

Ben:And we’re sitting here in the beautiful Usermind office looking out over the skyline of Seattle. So definitely a mafia.

Michel:Well, locally in Seattle, obviously Aptio was their first investment. That's where I was their head of product and that company has since IPO’d and Sunny Gupta was CEO. Ben had acquired his last company iConclude. So I mean there’s many more, right? Their initial investment and Okta and now Signal Effects where that's one of the CTOs of Opsware is now the cofounder there. And Karthik Rao, Eric Vishria’s roommate, is the CEO. It just goes on and on and on. It's pretty crazy.


David:It's totally crazy. Well, I can’t argue with those grades. 

Ben:I have far less perfect information, so B sounds great to me. 

David:Before we jump into Carve Outs, I’m sort of dying to talk about given all that, what’s it like now on the other side of the world where Ben is at Andreessen Horowitz and gets on your board. 

Michel:Well, number one, Ben is an incredible board member. So taking away Usermind and just my personal journey, he’s phenomenal. I think their whole philosophy – so now, obviously at Aptio I was in the leadership team and I was part of the board meetings and would present to the board. So I got to see that board and now I’ve got my own board. But it’s really striking to me, this thesis that they have even more broadly than Ben that operators, former CEOs make better board members. For me, I don’t know if that's true broadly because I'm working with Ben but I feel that Ben’s experience as a CEO helps me every day, every week, every month, every board meeting. He has been just incredibly invaluable in my development as a CEO and helping me kind of think about how to grow the company on every level. You think about board members are being really valuable in the context of a board meeting. Reviewing financials and helping you think about when to scale with function and when do you add what executive and kind of how are you doing from a customer traction point of view, and he’s phenomenal there. 

But Ben, to me, is as or more valuable to a CEO in your one-on-one’s where I might be talking with him about a management challenge, or how do you run a staff meeting as you grow the company? Or how do you think about different inflection points in your own leadership style and the way the business is changing? And where do you spend your time. Think about hiring your first exec. How do you do that and what are you looking for? There’s so many more ways that a board member adds value to a CEO’s both decision-making and growth as a CEO than the board meetings. And part of it is our relationship, I'm sure, because I trust him and he knows me very well. But he’s just an incredible sounding board with such a wealth of talent. I remember asking him, as an example, to share advice, I asked him when I was hiring my first executive, my first non-cofounder executive in the company kind of like, “What’s the central thing I'm looking for?” And I’ll just generalize it because I don’t need to talk about the specific role and his answer was: “An executive is someone who gives you leverage.” I'm like, okay, actually that is the ultimate truth. So if you’re hiring as a CEO a person, one of the things is they probably know more about their function than you. Which means that it’s very hard to interview them. But on the flip side, it also means that if that person joins and doesn’t give you instant leverage, you’ve hired the wrong person. And talk about like I’ve never in my entire life heard anyone in like a single word.  

Ben:Distill it so succinctly.

Michel:So succinctly articulate how to evaluate a hire and how to both before hiring them and as they’ve joined the company. So that's just a simple example of like one question I’ve asked him and the kind of response that I get. So I don’t know if that's the type of information you’re looking for but yeah, I feel blessed every day.

Ben:Hey, I learned something today.

David:Yeah, me too. Well, and this is something that I’ve been reflecting on a lot recently. Being in venture myself and Ben and I have been doing this together too. Really, this is making the case for as a venture investor, there’s this concept of being a company builder and contributing to the building of the company. You called it adding value, Michel. And I really think like if you’re not doing things like that, then what are you? You’re a stock picker. And does that even make sense in startups? You can’t pick stocks in startups. And if you want to earn returns for your investors and yourself, the only thing that makes sense really is to do approach this craft like Ben does and like Eric does at Benchmark and like many, many VCs do which is there has to be – and for you, I would imagine, that provides a hugely compelling value why you would want them on your board. 

Michel:Oh yeah. There’s so many elements to how you think about your board composition and I think what you’re looking for. But if you can get a person who is that level of genius who can contribute in such a fundamental way to value building. Let’s not underestimate kind of the value of the brand as well, so not just Ben Horowitz but Andreessen Horowitz. I remember in the early days of the company, engineers would say, I’d be like, “Why did you take the meeting with us?” and they’d say, “Well, you’re an Andreessen Horowitz company.” So the brand is also something that helps you build the company and separates you from other startups that helps you kind of be competitive in this war for talent which is happening all around us in Seattle. I think just the particular expertise that that board member brings is something extremely unique. I did not know Ben was going to leave and start a venture capital firm when he left HP. But it’s shaped my life. He’s the person who said to me, “you need to go be in a startup.” He’s why I went to Aptio and joined. In fact, at the time, he said, “You should just found.” But I had never worked in a startup so I wanted to go work for a serial CEO and learn something. And I'm glad I did. I think it's the right choice for me. I knew the right choice for me. But he fundamentally shaped my life trajectory. So if I shaped his by kind of changing his trajectory by the acquisition, he’s profoundly changed mine. I wouldn’t have known I’d be a CEO. I wouldn’t have thought I would end up in startups. I love product, I'm certainly a product person but I didn’t wake up at 23 thinking that’s what I was going to do. 

Ben:That's a great perspective.

David:Great note to wrap this one up on. We do have our last final segment of Carve Outs and actually this is a really good tee-up for mine for the week. Mine is Jimmy Iovine, the record industry executive and cofounder of Beats with Dr. Dre who he produced as a music producer, was on the Bill Simmons podcast on The Ringer last week, and it’s wonderful. It's the music industry and the record industry and lots of great stories there from all the artists from all genres that Jimmy worked with. But he talked about kind of just that, what you were talking about, Michel, and like the sort of courage to go and do his own thing and blazes on a path in the business and he talks about this concept of having fear and like fear can be sort of paralyzing and for a long time he was paralyzed until he found this thing, and that was music and the music industry that like the fear kind of motivated him. The fear was like I fear that I'm going to miss out if I don’t go and I capture this opportunity. He used the analogy of like when you’re playing baseball and either you’re in the outfield and you could think like don’t hit the ball to me. You could be fearful of it or you could say like “hit the ball to me” because I'm fearful like I'm going to make the play. If it doesn’t come to me I'm not going to make the play.

Ben:Right. It’s like opportunity to succeed rather than an opportunity to fail. 

David:Yeah, it’s great. Highly recommend. 

Ben:Ha. Man, I love The Ringer podcast. If you’re listening to the show and you’re thinking “I’ve listened to a lot of shows and I’ve listened to a lot of episodes at Acquired,” if there’s any that was particular good where I was like pumped up and you felt like I was on my A-game, it's because I listened to Bill Simmons before and there was that voice in my head and I was ready to go. So that's your Carve Out, you can take that one but I also recommend you listen to The Ringer podcast. 

Mine is a software package called StarStaX. It would be overselling to say I’ve been an amateur photographer. I’ve enjoyed taking pictures for a long time and especially I do these big backpacking trips every summer with my dad. And this time, I decided to carry the extra weight and bring about a 2.5 pound tripod out with me and try and do some Star photos. So this is super hard and I was bad at it 4/5 nights with either crazy blurry photos or like it was cold and the lens fogged or the clouds rolled in. But there was one night where I kind of nailed it. So the process is wild. You like leave the camera out on a tripod, you go to bed, you set an alarm, you wake up in the middle of the night like 3 or 4 hours later and you go collect it and you cross your fingers and hope for the best when you import it all later. StarStaX is this incredible cool piece of software on your computer that will take hundreds of long exposure photos that are taken over several hours and overlay them all on top of each other kind of automatically so you don’t have to do it all manually in Photoshop and really produce some cool star trails. So if anybody’s interested, we can link to that from the show notes and I highly recommend StarStaX. 

That's all we’ve got. Michel, thank you so much. Where can our listeners find you? Are you on the socials?

Michel:Yeah. So @MichelFeaster at Twitter. We’re at Usermind Inc. Both easy ways to kind of meet my acquaintance. We’re also on Facebook obviously as Usermind and I'm Michel Feaster pretty much everywhere socially. Or Michel at Usermind, if people are out there and you’re an early founder, you know, I don’t take every meeting because I'm super busy because I feel like I’ve only gotten where I've gotten because so many people have helped me. So easy to get me and if you can make time to help folks, I definitely will.

Ben:Awesome. Well, thanks again for coming on. Listeners –

David:Yeah. Thank you, Michel.

Ben:Thank you, Michel. Thank you so much to Perkins Coie for sponsoring this episode. Listeners, check out the Slack at Acquired.fm and we would love, love, love a review on iTunes. So, thank you so much. Have a great day!

David:We’ll see you next time. 

Episode 43: The Square IPO - Transcript

You can listen to the episode here.

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben:I also don’t think there’s anything that we want to edit or cut. 

David: Oh, it was great.

Ben:We’re getting good at this. [music] Welcome back to Episode 43 of Acquired, the podcast about technology acquisitions and IPOs. I'm Ben Gilbert.

David:I'm David Rosenthal.

Ben:And we are your hosts. Today we are covering the 2015 Square IPO to much, much demand from a lot of our listeners out there from David and from myself living on our Google Doc for way too long. We now have enough distance from it that we feel comfortable retrospectively covering it as an Acquired episode. 

David: Yeah. This one is going to be fun. I've been looking forward to this for a while.

Ben:Yeah. We’ve never said that on a podcast intro before.

David: Yeah. Basically, this whole show is just like what Ben and I want to do and what we want to learn about. 

Ben:We did our survey and we had a tremendous amount of feedback that said “It seems like you guys just kind of do whatever you want to do” and we hope that you guys like that because that is indeed how this works. 

David:Well, that's the best product advice out there, is solve your own problem, right?

Ben:That's right. Speaking of our survey, we promised to you guys that someone would win a pair of AirPods and while they are still shipping because of Apple’s excellent, excellent 6-week delay which congratulations to Apple for creating a product that has that much demand, they’re still in the mail but we’ve got a winner. So a shout-out to Tom who we will leave his last name anonymous, but Tom we have reached out to you over email and congratulations. And thank you to everyone that took the survey. It means a bunch to us. 

David:Yeah. Thank you. We got some great data, and not just data but feedback from you guys that hopefully you’ll start to see incorporated in the show.

Ben:We heard you loud and clear. We do not need to do Hot Takes. Got a lot of feedback about the Hot Takes. We’re not doing it. Unless we really need to, we’re not doing the Hot Takes.

David:Like today. 

Ben:Yeah. We love reviews. So listeners, if you have a minute right now, you can pause this very podcast, pop open the Apple Podcasts app and you likely are already in it if you are reflective of our analytics, and go and write a quick review. We really appreciate it. It’s how we grow the show, it’s how we bring in more guests and it’s how we do even better content. So thank you for doing that. 

We have a sponsor for this episode and our sponsor is Perkins Coie. With us today on the phone, we have Buddy Arnheim. Buddy is a partner in the Perkins Coie corporate law practice. Buddy is based in Palo Alto and has been the first counsel at companies you may recognize such as OpenTable, Trulia, Hotel Tonight, and Cloudera. His team at Perkins represents over 450 other VC-backed companies as well. So very impressive. All right. So Buddy, suppose our listeners aren’t in the market right now for legal services at this exact moment, is there another way that founders, investors, and tech employees should think to interact with Perkins Coie?

Buddy Arnheim:So for folks that are thinking of starting businesses or thinking of getting involved with early-stage businesses, our website has a myriad of resources. We’ve launched this thing about four years ago called The Startup Per Colator. It’s a repository of great information about the early-stage challenges that businesses face. It comes with a bunch of forums to help companies get informed and they can structure through seed financing and bringing on employees and provide them equity in a sense. So there’s a whole bunch of resources at Startup Per Colator that I think folks that are interested in starting companies are getting involved in the early-stage businesses to benefit from.

Ben:Great. Thanks so much. If you want to learn more about The Startup Per Colator or reach out to Perkins Coie, then you can go to StartupPerColator.com. That's Startup P-E-R-C-O-L-A-T-O-R.com. Or if you don’t know how to spell that, you can just Google it like I did. So thanks to Perkins Coie.

David:Thank you guys.

Ben:David, anything else before we dive in?

David:No. Let’s do it. Shall I start with the history and facts? As always.

Ben:As always. 

David:Well, today we start not where I think many listeners might think we would start when looking at the Square and the Square IPO, which would be Jack Dorsey, of course, the man most associated with Square. 

But we actually start back in 1991 in St. Louis, Missouri with another man named Jim McKelvey Jr. who is a co-founder of Square. Jim had been born in 1965. He was raised in St. Louis and his dad was actually Dean of Engineering at Washington University in St. Louis. And Jim Jr., his dad was Jim Sr., Jim Jr. went there for undergrad. He majored in Computer Science. He also got really into glassblowing while he was in college and he was an artist. He was a budding Dale Chihuly. Shout-out to Northwest artists here, the other University of Washington area. After college. So this is the late ‘80s now. Jim worked for IBM for a couple of years and then he caught the startup bug and he went and he started his own company which was called Mira Digital Publishing. 

Now if you’re wondering what all of this has to do with Square and Jack Dorsey, just bear with me for a minute here. So Mira, this is again late ‘80s to early ‘90s, initially they created a product that was a competitor to Adobe Acrobat and PDFs. But unfortunately, Adobe existed and so that didn’t work out too well. But they went at it for a couple of years and then Jim started to realize Adobe was going to win the market. The whole landscape in technology was changing as the internet was coming and so he decided to pivot the company. And this was mid-90’s now, this was 1995. So he wanted to pivot the company into going into publishing actually, into conference publishing. But nobody else in the company really was on board with this idea, with this pivot except for one person. And that was his 15-year-old summer intern who was in high school, and that person’s name was Jack Dorsey. 

Ben:Wow. That’s a connection.

David:We are reaching way back here at Acquired. And Jack had also grown up in St. Louis, Missouri many years, after Jim and had gotten a summer job in high school working for Mira. But Jack was totally onboard with the pivot and so he was kind of the first person to get bought in, and that’s how the relationship between the two official cofounders of Square started. 

Ben:All right. So they knew each other for years then before the founding of Square, like all the way through Twitter, all the way through even before that obvious. Take us through that.

David:Well, obviously many, many years go by and a lot happens. McKelvey, he pivots the company, they get into conference publishing. But he also kind of rekindles his love of glass blowing and he starts another company called Third Degree Glass Factory. And he starts blowing glass again and he gets really well known for making glass faucets, so like faucets on your sink. They’re really beautiful. We’ll link to it in the show notes. The company still exists today and he makes glass faucets. So this was many years later. This was kind of late 2000s, around 2008-2009. They’re beautiful works of art and so he was selling them, but he couldn’t get set up with all the financial institutions, his bank and credit card companies to be able to accept credit cards. So he had to sell them by cash or check and that was really kind of limiting the amount of $2000 glass faucets that he could sell. 

Ben:You got to imagine if just one of those sales falls through, that's a huge deal. Depending on your lifestyle, like if you’re a glass blower and you’re kind of a starving artist and you just have one of those fall through, it changes your whole life.

David:It totally does, right? And not to mention, I mean, you have to do the work, you have to blow the glass. You’re doing all this by hand, putting all this effort into it by yourself before you even try and sell it. And then if you can’t sell it to a lot of your potential customer base because you can’t accept credit cards, that's kind of a problem. 

Ben:We live in a Square world now so we’re used to seeing all the food trucks with Square readers. But if you think about the type of business owner who is able to get approved for a merchant account these days, you need to be tremendously established. It was really unfriendly to entrepreneurs and not tech entrepreneurs but like people who were starting these little businesses. And in fact, getting ready for this episode, I talked to someone that had a business that had around 100k of cash in the bank. It was doing like a quarter million dollars in sales a year but was new, it was sort of a few years old and couldn’t get a merchant account with a bank. How insane is that?

David:It's totally insane thinking back on it and now how much Square and other financial startups like Stripe and the online world have changed the way this all works. But even just a few years ago, you needed to be super established doing tons of revenue before the financial system would kind of let you in. 

So Jim’s got this problem. He thinks maybe technology can solve it so he calls up a good buddy who just actually, coincidentally, got forced out of his current startup and that was Jack who had been CEO of Twitter famously from 2006 to 2008, and then was forced out of the company. So he’s looking for a job, it’s late 2008 and his old first boss Jim calls him up and says “I've got this problem.” 

Ben:I'm thinking back to like my first boss now and imagining ever getting that phone call. I was an umpire and so I’d be the guy that ran the summer umpire’s group, but yeah, I can’t really imagine. 

David:Well, you could have started BAMTech. 

Ben:That's right. 

David:More on that later. So I just told this whole story about the origins of Square. And it’s a great story and it’s the official story. Now, is it the true story? That's a little more complicated.

Ben:David, why have I heard that there was like seven founders of Square?

David:Yeah. So there was a little more going on behind the scenes than that. And impossible to know exactly what. But it is true that Jim was Jack’s first boss and that he called him up in late 2008 right after Jack was forced out of Twitter with an idea to start a new company. It turns out that probably most likely, and Jack’s actually talked about that, that idea wasn’t Square. It was to start an electric car company and compete with Tesla. 

Ben:Well that's very different. 

David:You know, it’s almost like accepting payments via plugging into your audio jack on your phone, almost. But at some point along the way, a third person gets involved and that person’s name is Robert Morley. Robert or Professor Morley was a professor at Washington University in St. Louis. I believe it was that Jim and Jack initially approached him about potentially helping with this electric car idea. And Morley says “No, that's a terrible idea but I've got this thing in my research that I'm really focused on and I’ve been working on for years, decades. And that's around card reading technology, payment card reading technology and I’ve got this device that you can plug into a mobile phone and it’ll read credit cards.” That, according to Morley’s side of the story, got Jim and Jack really interested in this idea and it was also true that Jim was a glass blower and couldn’t sell his faucets via credit card. So they got really excited, turned them on to the potential of using mobile phones to accept credit cards rather than the super expensive and really clunky and big Point of Sale systems that NCR would sell, National Cash Register or other sort of big fintech companies. 

So one way or another, they start working on it. Morley was never kind of officially part of the company. He did in 2014 before they went public, he did sue the company for both patent infringement on the card readers and forcing him out at the founding stage. And Square and the company and he settled in 2016 for $50 million.


David:So Morley got $50 million, everybody’s happy and Square is a great company today. 

Ben:Man, so you have to imagine like how does that all go down if you’re Morley. Like it’s based on a lot of his research. He had all these conversations, it seemed like he was in. Presumably they would sign some documents when he parted ways but are you just sitting there thinking like “Well, at some point I’ll get a pay day out of this so I’ll just wait till the right exact time to sue.” 

David:Yeah, I don’t know. We didn’t talk to Morley or Jim or Jack for this episode and I doubt they would tell us anyway. 

Ben:Yeah. But note, I’ll pull forward a tech theme here that this is not the first time we’ve heard this. There are so many scenarios where right around acquisition, right around an IPO, this lawsuit comes in and it’s around the founding of the company and it’s really messy. And you could take away a lesson that's like, Hey, have your documents all buttoned up from your founding era. But I think the real takeaway is like, Hey, have everyone be fair and equitable.

David:Yeah. At the end of the day, everybody is probably pretty happy here. But I think this also highlights this whole thing, both the official story and the unofficial story. Highlights what I think Jack in particular is really, really great at, like what his super power is – and we’ll talk about this more in the episode. But he gets the power of stories and the official Square origin story is super powerful. Right? Like I'm an artist. I'm making glass faucets and I can’t sell them, but I have to make them upfront and I'm locked out of access to the modern financial industry. 

Ben:Yeah, this resonates with so, so many people and I think I’ll put forth another tech theme because we have so many good tech themes that I think it's worth doing these sort of like popcorn ones early. Reinvented founder stories I think are probably more common than actual organic, live-as-it-happened founder stories. Like when you hear the picture perfect, too good to be true entrepreneur post-IPO describing this simple insight that they had when they were... you know, who knows if this one’s actually true and out. But I’ll pick on and say “I don’t have any information.” But with Zillow, you hear Rich Barton talk about how he and Lloyd were both looking for houses after leaving Expedia and they couldn’t believe that it wasn’t online. Like you got to think that it’s much more like, “Hey, we should start a business together. Here’s a few sectors I'm interested in. Let’s assess the viability of this.” I think it looks a lot more like what Travis Kalanick would describe as a jam session between very entrepreneurially minded people that it does this idea popped to me on the head one day. 

David:Indeed. It’s a good story though.

Ben:It's a great story.

David:And I think like I was saying, you need a story to communicate. Like it’s not necessarily bad or wrong to create these founding methodologies because that part of how you communicate to your potential customer base, what the company does to the employee base. Like you embody the culture and the values of a company in these stories. 

Ben:Yup. And there’s so many great things that fall out of it. Like your engineering, let’s say you’re doing Agile, like your user stories. Like you have your first user story. You have your very first when you’re describing your market, it’s very easy for an investor or a partner or a customer to conjure up to Jim the glass blower in their head. 

David:Yup. Well, speaking of stories, we’ve got a couple more before we’re done with history and facts here, and they’re pretty good. So 2009, one way or another the company is off and running. Jack is the CEO. He is either chairman or executive chairman at Twitter but he’s basically like barred from the company. There’s a whole book, the Hatching Twitter all about this which I actually haven’t read. I need to. But I think at one point they shut off his email account. So he’s all in on Square at this point. And Jim is the cofounder and he’s the head of hardware. So they get to work, they have a name. They have a really great name. They have an iconic design for the card reader that's going to plug into phones, iPhones and Androids. 

Ben:What’s that name that they have?

David:The name starts with an S and then a Q and then a U. It’s Squirrel. The card reader design also totally iconic and matches the name perfectly. It’s an acorn. So yeah, they go down this path and, fortunately, for the world and for Square, before they launch they go to Apple, they go to Cupertino. They meet with Scott Forstall who at the time is like the most important person besides Steve Jobs when it comes to the iPhone. We’ve talked a lot about Scott on this show. And of course, Jack is he’s been forced out of Twitter but he’s a celebrity so this isn’t just some rinky-dink startup from St. Louis, no offense to St. Louis, but easy to get a meeting with Scott. And Scott points out to them that, hey, they’re having lunch at Apple at the café there and Apple actually uses another company called Squirrel Systems that does their Point of Sale system at the café. So Jack’s like, “Hmm, well, that's not a good idea.” So they change the name to Square and the fortunately they also change the design of the card reader to be a Square. 

Ben:And it's worth noting at this point that Square was not a Point of Sale company. So it wasn’t this obvious like you would have searched other Point of Sale systems to realize, “Oh, these are Squirrel Systems.” If you remember at the beginning of Square, it was more about accepting credit cards on the go and just this single dongle to plug into your iPhone. There wasn’t even an iPad app, let alone this ubiquitous every coffee shop on the planet uses Square register as their Point of Sale system. And so you could imagine like you think you’re competing in this category of we’re just working with kind of not the underbanked but like the under merchant accounted right now, we’re providing this new mobile payment system. Mobile is new, it's only two years since the iPhone. You really don’t think you’re going to be competing really in that Point of Sale market of people that stand behind a counter. 

David:I remember when Square first came out being really excited and getting a reader myself. I mean, I wasn’t a business. I didn’t sell anything.

Ben:Yeah, me too.

David:I thought it was like, “oh, this is great. When I sell stuff on Craigslist, I can take payment on credit card.” That's what I thought I would use it for. 

Ben:In fact, I even used it like what people use Venmo for today because I was so excited. My buddy Andy and I were taking a backpacking trip and we both bought the same backpack and I put them both on my credit card. I was like, “Hey, pay me with Square.” I like, pulled out on the way home, I like pulled out my card reader and accepted his credit card knowing that I was going to take –

David:Oh, man. You’d be paying the fees.

Ben:Yeah. Like I got less money. I paid the fees as the merchant. But it was like too cool not to do it.

David:You wanted to take payment on a credit card on your phone? 

Ben:You know, as a person I’ve never been able to do that.

David:I know. It’s pretty cool. That's the end of the fun stories of the history and facts for Square. But I think this is really the key innovation. Part of it is the hardware thing and we talked about the lawsuit and Morley. But part of the innovation was being the technology to accept payments on your phone, but the bigger part of it was enabling anyone to accept payments, like we were talking about. It was this huge barrier to doing so and entering the industry. And what Square was able to do and it also I think was technology innovation, but it was on the backend, they were able to let so many people like you and me, Ben, consumers into this world of accepting payments because they got really, really good at fraud prevention. This was part of the reason why the industry didn’t let anyone in before was protectionism probably, but the stated reason was fraud. That if you let anybody accept payments, you’re just opening the door to tons and tons of fraud happening.  

Ben:Yeah, I think you nailed it. There’s a couple of amazing data points here. So I think you’re right that the thing that Square did that's entirely differentiating is unlocked a completely new set of people who could accept transactions, right? They did it an incredibly design focused way. So every POS system ever has sucked. Right? It’s just been awful and they invented this category of sort of cloud Point of Sale which is really the big market than they’re in now. It’s not as much mobile card reader as much as it is a cloud Point of Sale system. They’re competing with like the micros of the world there that are sort of the tethered to a phone line Point of Sale system and really hard to integrate with. So when you look at the market they were entering, so they did three things really well. They did the incredible, amazing user experience as a merchant. They unlocked new merchants, secondary merchants before, and they did the best job of reducing fraud with this new merchant class. 

So when you look at the Square device was revolutionary but it wasn’t the first. I mean Intuit had something called GoPayment that was totally already catching on. It wasn’t even like, “oh well, you can find prior art” or something like that. It was totally happening but Square had a phenomenally better experience. 

David:And I think PayPal had a reader too. 

Ben:That's right. 

David:Afterwards. But it launched pretty quickly afterward. 

Ben:And the Square folks called that the triangle because it was shaped like a triangle and was copying Square in a lot of ways. 

David:Oh man, that thing was so ugly.

Ben:The interesting data point around this is, both PayPal and I think Verifone was the other one that basically weren’t doing the underwriting in the way that Square does and they were taking huge losses. So they were actually subsidizing payments when they realized, oh crap, there’s this entire new class of merchants emerging. They didn’t have the underwriting system and basically the machine learning system. I mean, that wasn’t all the rage yet but effectively, machine learning system to constantly be learning and constantly basically be re-underwriting that merchant after every transaction. 

David:And whether new merchants and existing merchants were going to be fraudulent or not.

Ben:Exactly, exactly. So Verifone actually shut down their competing product because of fraud losses because they were taking kind of a 1% loss on every transaction for every customer. When they shut down, they very publicly accused Square of subsidizing the small businesses. And Square’s like actually a core competency of our business, is we’re really, really good at this. The trick that they were using is a really interesting one and obviously they have this incredibly sophisticated team that does this. But they basically would only take on a little risk at first so you couldn’t do a bunch of transactions and massive transactions at first. They would just say, hey, we’re not going to put you through a bunch of hoops. We’re just going to give you a little bit, basically a little bit of credit. We’re going to let you start racking up your transactions until we trust you and with every time that you completed a transaction and it wasn’t a chargeback and it wasn’t fraud and it wasn’t all these things, they basically gave you a little bit more rope. So that way, they could actually get you started quickly and trust you more over time which was just nothing, it was completely innovative in this industry. 

David:Yeah. Just to put a data point around that. When Square started, there were 30 million businesses in the US that had under $100,000 in revenue. That's just businesses, people that had already incorporated a business. But only 6 million of those could accept credit cards. So 24 of the 36 million small businesses in the US under $100,000 in revenue could not accept credit cards. Like that's just unfathomable today. 

Ben:Man, if you are like Visa, Mastercard, American Express, you have to be just besides yourself at the market this unlocks for you.

David:Yeah, totally. So 2010, they launch as Square, not as Squirrel and with the square reader, not the acorn reader. And they make the card reader free. So if you want to join Square, you sign up online. You enter some information, it’s pretty easy. You give them your address and then they send you a card reader in the mail for free. Versus like buying a $2000, $5000 Point of Sale system from Verifone or NCR or whomever. It's a game changer.

Ben:Yeah, On top of technology innovation, just massive business model innovation.

David:Totally. And then, once you start accepting payments, it’s a straight 2.75% charge on every credit card transaction which is different from how it worked with large providers at the time. There would be a sliding scale. It would depend on what type of card people were using, if you were using the...

Ben:David, have you ever applied for a merchant account before? 


Ben:When I was working on a startup in college, I actually applied for a merchant account. You get this thing that's like maybe 12 or 15 pages thick and it has, I don’t know, 50 to 100 lines on each page and each one is a different scenario where you have a different fee structure for each card. So there’s a zero way that you could ever like put that in a spreadsheet and calculate it yourself and make sure they’re charging you right. Or perhaps model out what your average fee is going to be for your business because it’s literally like, oh, if someone types in their card number versus swiping it, it’s different. If it’s this card that is a Visa Signature instead of a Visa, or it’s underwritten by this bank, or whatever. Every single one is different. 

David:Yeah. And if you’re like a retailer or a café or a food truck, like your margin is already super small to begin with. So now you’re just like you can’t even calculate whether you’re profitable on things. It’s just terrible.

Ben:Can we just pause for a minute and say the credit industry is like the biggest fast one pulled of all time. Like, can you imagine, so let’s say we live in a world where the credit card system was never established. Suddenly, this guy’s like, “Oh, I'm going to start a credit card,” and he comes to you as a retailer and he says, “Hey, people can pay with this thing instead of cash and they’re going to want to because it’s going to be really easy, and I'm actually going to take like 3 percent of the entire business.”

David:Yeah, but I'm not even going to tell you how much I'm going to take, like I'm just going to run some voodoo and then you got to trust me. 

Ben:Right. Unbelievable. This is a little bit of like the better consumer experience always wins out. Like if somebody provides the way that people are going to pay for services at your business that is the easiest thing and there’s sort of a network effect going on like it’s going to happen – so there’s another tech theme pulled forward – then it’s going to happen. But like just can you imagine how resistant retailers must have been when this first started of like suddenly you lose 3% of your –

David:Yeah, well it took decades. The other thing that this hypothetical shyster named credit card would pull on these business, is not only am I going to take an undefined and calculable percentage of your sales. Rather than when you take cash, then you have cash. Like it’s there, it’s in your cash register.

Ben:By the way, I may take this away from you. 

David:Yeah. Well, I may take it away from you, one, via chargeback. But two, even if I don’t take it away from you, I'm not going to give it to you for like 30-45 days. Unreal. So when you took credit cards before, that money wouldn’t show up in your bank account for at least 30 days and if you’re a small business trying to meet payroll, trying to pay off your suppliers, like that's a problem.

So the other big product feature that Square had was they deposit the funds into your bank account within 1-2 business days, which again, was huge compared to the industry at the time.

Ben:Yeah, that's pretty incredible. 

David:How they did all this and they launched pretty quickly after they were founded, I don’t know. I mean, that would be a great story of building all this, like this is not easy stuff.

Ben:Okay, so at Pioneer Square Labs we work with these startups and we’ve started 60 and we sort of killed a lot of them along the way and we spun out 6. Every single one whether it's a successful thing that actually launches or an early project you’re working on, like it is so hacked together and the customer experience is so like almost there at the start. You’re just trying to prove that your one insight is true. And I remember when I found out about Square like the first press release, you go to the website and it’s like one of the best designed websites I had ever seen because it’s like a huge tenet for the company and a principle that Jack believes in. In fact, like I was doing web design at that time and web development, and people would just keep pointing back to Square, like, “Oh, make it look like that.” And every iteration for years was like the gold standard of beautiful designed website. And when my Square reader arrived, it was beautiful. The packaging was Apple caliber, like the messaging was all perfect. Like, there was nothing about this company at least as a customer that felt like scrappy or new or at experiment. It’s like it was birthed as a perfectly formed product.

David:Yeah, it will be great. It would be super fun to have somebody if you’re out there who was there in the early days with Square, come on and do a follow-up with us. Like, how did you build all this stuff in 12 months or less? It would be cool. In 2009 and 2010, no less, when it was definitely not as easy as now to build all this stuff.

Ben:Right. And it really speaks to Jack as a product visionary too. I mean, when people referred to him as Jobs-like, I think in the way that Steve Jobs and Jony Ive and those folks could conceive of something and then release it perfectly into market the first time. Square has iterated quite a bit in a very Apple way of small interactions over time and small iterations over time. But amazing how good it was at first.

David:Yeah. So, they launch in 2010. Before they launched, they had raised a Series A from Khosla Ventures in 2009. But they launched and basically they just grew like wildfire. I mean, we’ve talked about all the reasons why this was a complete game changer for small merchants and people that didn’t even accept payments at all before. Launched in 2010, there is a Series B from Sequoia from Roelof Botha who was some partner at Sequoia and had been the CFO of Paypal in 2011. Then a couple months later in 2011, they raise $100 million Series C from Kleiner. 2012, there is another $200 million from Chris Sacca and Rizvi Traverse. Chris had used that vehicle to buy up a lot of secondary shares in Twitter, famously, and then he used the same vehicle to invest in Square. And then simultaneously, well, right after that, then they do this enormous deal with Starbucks in late 2012 and this was such a huge announcement at the time. So Starbucks invested, as part of this round, into Square and committed to moving all of their payments at all Starbucks-owned stores in the US on to Square technology. And up into this time Square was for the customer we’ve been talking about, the sort of small merchants. But the idea that a Fortune 500 retailer would move everything on to Square was just pretty shocking at the time. 

Ben:And I actually didn’t dug that much into this deal but to me, it’s shocking that Square was anywhere close enough to feature complete, to make this deal make sense. I mean, I think there’s a lot of discussion we’ll do about this deal, of the financials of it. But from a product perspective, I remember shocked to that like, was Starbucks going to contribute to. I guess Square probably had to do a ton of sort of custom development effort and it probably forced them to enable a lot of the functionality in the Square register that they have today. 

David:Yeah. And we talked about this a little bit in the Starbucks episode with Dan. But I think a couple of things. One, Square wasn’t ready; this was a really bad deal. And I joked earlier that the end of the fun story in this episode for Square, at least until the very end of this episode, but this was the beginning of the end of the fun. But I read a lot of things written by Jack and interviews with him looking back on this in preparing for the episode and, you know, he does say and he’s probably right that what this deal forced Square to do was become enterprise class in terms of payments and fintech and security really quickly. They basically had no choice.

Ben:Yeah, that's interesting. And it really also I guess gave them those product features to move a lot more of their business to this point of sale market instead of the mobile card payments. I think the difference is subtle and I mean it’s best simplified as going from iPhone to going to iPad. But they forked the code base. It became Square and then a different app called Register. If you look at the vast majority of their revenue today, they have on a per quarter basis 482 million in transaction-based revenue, and everything else pales in comparison. It’s like 59 million in subscription and services based, hardware revenue. They do 10 million but 14 million of that is a loss. The vast majority of that 482 million is really in the Point of Sale category that is not quite where they started. I mean, they’ve used that as a wedge to get into the merchants that otherwise wouldn’t have been able to get an account, but now they’re in this rising tide of cloud point of sale. I was thinking about this before the episode. A lot of the growth ahead of them is really just this industry of cloud POS growing much more so than Square being able to continue to bring on more people that wouldn’t have been able to be merchants before or perhaps stealing share from other cloud POS providers like Clover or there’s all these other new ones launching that it’s really like they kind of pioneered this category and then really solidified their position in the category by forcing themselves to do all this work, much of it probably from the Starbucks deal and now it’s just like they get to sit on top while that industry accelerates. 

David:Yeah. Well, I would agree but I would argue for a slightly different framing of it which is it’s not just cloud POS and I actually think that the software and data products line item of other revenue they have is hugely important. What this really did is it took Square from being just a payments rails system for anybody to accept credit card payments, to a whole suite of a solution for a merchant of any size really but a world-class suite of tools for a merchant to run their business of which payments is probably the most important part that's accessible to anybody from the coffee shop down the street to Starbucks. And that's what I think this deal did. So if you look at the Point of Sale system itself and the Square Register, it’s no longer just about taking payments. It's about managing your inventory, managing your skews, managing your employees, time punching in and out, and then since then, Square has added so many different features. Payroll for employees, Square Capital to do lending against your revenue. Appointment booking. Basically everything you would need if you’re a business to manage and run your business. And I think that all really happened or started because of this Starbucks deal.

Ben:I could see that. I like that framing. It is worth noting and I think it’s another business model innovation that they’re bundling all this stuff in largely for free or for a very reasonable cost and the way they monetize it all is through the transaction. So for Square, it’s not like what else can we sell through this channel. It’s more like what can we add to this channel, what can we add to make the lives of small business owners easier so that, number one, they stick around longer and continue to use this product. Number two, their business does better so that we both do better. 

David:Yeah. Well, it’s a flywheel. It’s an Acquired flywheel. And it’s like AWS, like they charge some amount of fees for some of their services and some of the services are free, like they bought Caviar. And so for restaurants, Caviar food delivery is an option that they offer. Then there’s Square Capital which is loans. And they make money off of those business. But really, the beauty is in helping the merchant grow their business which grows transaction volumes so Square makes more money. And then they use more Square services so they make more money from the ones that they charge for and the whole thing drives itself. 

Ben:Yup. Great point. And so this Starbucks thing, it leaves them with a massive hangover, like this is something where – this underscores the point. So I was looking at the investor site earlier and checking out the way they break out revenue and I mentioned subscription and services-based revenue and hardware revenue. There’s actually a fourth breakout which is Starbucks transaction-based revenue and it’s obviously now that the deal is over, it’s 0 but it’s still on all their year-over-year comparisons because it was broken out separately, it was something that they generated good revenue but extremely costly to the business.

David:Well, let’s jump forward and accelerate through the end of history and facts here where we’ll cover all this. So last we left them, 2012, they had raised this huge round, done the Starbucks deal. They were valued I think at $3.25 billion in that round. Remember, this is 2012. The company was founded in 2009. Then, in 2014, kind of rather than go public, they’re toying with going public, they decided instead to raise $150 million Series E from the Singapore sovereign wealth fund and Goldman Sachs. We’re going to come back to Goldman in a minute. And that's at a $6 billion valuation. That round becomes pretty important in a minute.

So, in the meantime, growth is great. They’re growing payment volumes hugely. They’re growing revenue hugely and they’re making money off of the transactions. They’re making real margin dollars off of it. They’re still paying down their fixed cost. But the business is working.

Ben:I think they were coming out of that Starbucks thing and looking toward the IPO, they were close to break even if you look at them today. They just took a $16 million net loss on last quarter but if you look at the way that that's really come down, I mean you’re right, David, on a sort of a per transaction. 

David:So they’ve completely paid down their fixed cost and they have a bright future ahead now. So all this is going on. This is throughout 2014. 2015 rolls around. Not a good year for Square. Well, so the first thing that happens, June 2015, Dick Costolo resigns as the CEO of Twitter. And Jack, a Steve Jobs moment, comes back as interim CEO of Twitter, which is also a public company at this point. Square is not public yet but they’re preparing to go public on the back of all this momentum. But during the year they realize this Starbucks deal is a terrible deal and they are financially – now strategically it was great for the company for all the reasons we said, but because of the pricing that they’re giving Starbucks, they’re just losing money on every transaction that they’re handling for Starbucks. 

Ben:They did renegotiate that at one point, right? 

David:They did renegotiate but the outcome of the renegotiation is basically that Starbucks is going to pull out. Because part of the renegotiation was that Square no longer had to be the exclusively provider for Starbucks for payments and Starbucks could get better pricing elsewhere. So they over time basically just start pulling out of the deal. So that's throughout 2015. Then October of 2015, Square is all working to go public throughout the year, is dealing with all these things and they eventually do go public in November. October 5, 2015 - Twitter announces that Jack isn’t interim CEO, he’s permanent CEO of Twitter and also permanent CEO of Square. So he’s truly like Steve Jobs with Apple and Pixar at this point. 

Ben:Was he CEO of Pixar while being CEO of Apple? 

David:I think he was, yeah.

Ben:Wow. Parallels in more ways than one but yeah, I totally remember this moment of like, okay so can you do that? Is that... what? 

David:Yeah. Is that possible and everybody knew Square, it hadn’t been publicly announced yet but everybody knew they had privately filed to go public. We’re going to do our narrative section that we now do on IPOs in a minute. But let’s just say the narrative was not good in the press. So November rolls around. Square had announced their public filing. They had done their road show all while Jack is also now the new CEO of Twitter and they go public on November 19, 2015 at $9 a share which equates to a $2.9 billion valuation. Now, remember the last round they did was at a $6 billion valuation. So it then got widely reported in the press, it is ratchet time.

Ben:And that $9 a share was below the published range of what they were shooting for, $11 to $13 per share.

David:Yeah. They placed under the range. They said they were aiming to do the IPO at $11 to $13 a share. They end up pricing even under that. Basically, the whole tech world though this is like the first unicorn to die.

Ben:Oh, yeah. This was a moment where everyone thought the music had stopped. Like the doors were closed on the tech IPO market, people were worried about a global financial crisis or at least a recession and Square was trying to tell this other story of like, “no, it’s great. We’re doing better than ever and we’ve got sound fundamentals,” which is totally true but, like, the story that they were telling the world, everyone’s thinking like “Are you crazy? Nobody’s IPO-ing right now.” 

David:But they did. And so as a result of it and this got so much press, this ratchet, so at the last round that they’ve done, which remember, Goldman Sachs was a big part of investing into this last round and then Goldman Sachs led the IPO.

Ben:It was like 50 million or so.

David:It was 150 million and I think Goldman invested 50 million. I could be wrong on that.

Ben:Yup, they did. 

David:So though the terms of that round were that the company essentially promised those investors in that round a 20% return on their money at IPO. So not just where they get their money back at the same valuation but they would also get a 20 percent return. And the mechanism by which that played out, remember the IPO happened at essentially half of the valuation of that round. So not only did they not get a return, they lost money. The way it played out is the company had to issue additional stock to those investors when the IPO happened, and $93 million of additional stocks. Now that's not terrible. The company had a $2.9 market cap, but it’s a lot. And also, this got issued as stock. So if those investors held that stock, since then the company has basically just killed it because they had sound business fundamentals and lots of growth potential ahead of them and a huge TAM. So now they’re trading at $25.59 as of today, up hugely, almost a $10 billion market cap. And so if those investors had held on to that stock, the stock that they bought in the private round initially and then what they got in the ratchet, they would just be making huge returns right now. 

Ben:So let me talk about the conflict here because this blows my mind when we were digging into this and really to get this out. So like the way IPOs work is the bankers get basically banker fees for taking the company public. So Goldman Sachs gets about $10 million in banker fees from this IPO which makes a lot of sense, given where it priced, given all those things. They also get, whatever, $90-something million in that ratchet because they participate in a huge way in that previous round. When you look at this, the incentive for Goldman as the lead underwriter on this IPO is to actually price it lower because their banker fees that they get as a percentage of the valuation of the company is actually significantly less than the amount of money that they would get from it being priced lower. So obviously it's different people and Goldman doing this, but it’s kind of shocking that that’s possible that you would pick Goldman, given their conflict there. 

David:It's totally crazy. Banks have long argued that you should let– It’s been kind of like common wisdom in startup world that if you’re thinking about going public and one of the main investment banks wants to participate in sort of a mezzanine round before you go public, you should do that because then you’re going to align incentives with them if they ultimately do take you public where the higher they price the stock, the more money they’re going to make because they’re already a shareholder in your company. But if you have a ratchet like this, then just as you said, Ben, you’ve set up the incentive for them to price the stock lower because–

Ben:It’s perverse.

David:It's totally perverse. And who knows what did Goldman intentionally guide the company to price the IPO too low. Who knows? But here we are. And the facts of the matter are just like you said, Ben, the company has killed it over the last year and a half and the stock is now up almost three times since the IPO. 

Ben:Let’s talk about why they’ve killed it. So Square, as we both argued in different ways, I think that they were sort of the creator of this new category of cloud POS and they are the most well-recognized name in it and they’re doing extremely well in this massive rising tide. So they’ll continue to kind of grow with that industry and your point of view that, yeah, and indeed they also were bundling all these other amazing services to make these businesses perform better and make all the card fees on those but also increase the number of transactions that they take a piece of. So great, the company is doing well.

The other magic to this whole thing is this is the sort of business that also has zero churn because for Square, on a per cohort basis, so for folks that aren’t familiar, a cohort is like a whole bunch of people who are becoming new customers in the same time frame. So they would all come in and their net churn was zero. So basically what that meant is the way that this business works is they would lose customers, they would churn out at a certain rate but the amount of money that the customers from that cohort who stayed there would generate from growing their business was approximately equal to the business that Square was losing from these customers that churned out of the cohort. So actually if you look at every new cohort they add, they flatten out over time and make a consistent amount of revenue for the company basically indefinitely. And so it makes a lot of sense for once Square has this cocktail TV ratio where they can figure out, “boy, when we deploy X in marketing spend, we make it back, plus 30 percent or so in less than 2 years, and we’re able to just keep pouring money on to do our marketing efforts and we just keep getting basically zero net churn cohorts that all stack on top of each other forever.” So, very predictable business in an industry that's absolutely a rising tide. It’s something where if you look at it on its fundamentals rather than as like a speculative “who knows if this will actually pan out” thing, it seems like it’s a great growth company.

David:We basically talked about the content of the narrative section here but it’s like a tale of two stories, a tale of two companies here. It was the best of times, it was the worst of times. If you listened to the press around the time of the Square IPO, and I remember lots of investors sort of talking too and chattering them, it was like this is the worst of times, like this is the death knell for all these unicorn companies and Square is like prime example of super overvalued and it turns out that their actual business which is payments is a super crappy business, really low margin, if any margin. And example #1 of that is look at this Starbucks deal, like it sucks. Square is losing so much money on it and that means they’ll never be able to serve large margins. So this company is doomed, right? Like that was the narrative that was so dominating the press cycle and the investor cycle but I think the lesson here is like in any kind of situation like that, you really got to dig into the company’s fundamentals whether the narrative is like this company can do no wrong or whether this company is doomed. And Square’s narrative through the whole thing, you read the IPO or you read the S1, they actually say in the S1 like “we serve small business merchants. We make commerce easy. We make it accessible to everyone, like we’re not a payments company. We’re about helping merchants increase their business.” And because of these flywheel effects, that is good for us too. 

Ben:Yup. And boy, it's funny. Not to talk about Rich Barton in every episode now but when you hear him talk and he talks about the name Expedia and the name Zillow, like picking an empty vessel and then you get to fill it with your marketing and you get to fill it with your product and your brand that the value prop to customers, like Square was not a payment word. It’s something that they can choose to fill with whatever they want to be. In the way that Snap is a camera company and we all said, “Oh, Snap is a camera company.” Like, Square is a payments company. Square is a small business company and I think that’s got a lot of power to it.

David:There’s a great interview which Jack, he talks about, and he’s asked sort of like, what is Square? And he’s like, well, there are three things that every business needs. And he says whether you’re Facebook or Twitter or whether you’re a coffee shop, you need access to capital, and capital can be raising money but it can also be sales from your customers, like we were talking about earlier. If you can’t access the capital from the sales you’re making to customers because you’re not going to get for 30-45 days, that's a huge problem. So you need access to capital to build and grow your business. You need to acquire customers and then you need to retain customers and build loyalty. Like what Square has done I think, or at least what Jack would say Square is trying to do, is to help small business, well, businesses of all types, physical businesses do all three of those things better. 

Ben:So drifting toward what would have happened otherwise, let’s talk about access to capital a little bit. This will help us guide a little bit of our criteria for grading this toward the end of the episode will be kind of two-fold. One is always did this IPO allow them to do something that they previously couldn’t do before, like was it a good business decision to IPO. The two components of that are the idea of it and the execution of it. So kind of working backwards from them and thinking about access to capital, after the Starbucks thing, they’re left in this place where they’re near cash flow positive, like that is right on the horizon. They know that when they spend marketing dollars, this very predictable thing happens where they are able to get a return on that marketing spend. So it's really about hey, let’s go get some more capital so we can keep taking advantage of scale, getting closer to cash flow positive and pour some dollars on this business. So then you have this decision of do you do that from the private markets like we did our Series D and we did with our Series E, or do we go to the public markets. This isn’t really talked about enough but if you look at sort of liquidation preference in all these venture rounds and all of that stacking on top of each other, the valuations are a little silly because think about it this way. If you’re a public company and somebody says “I will give you a valuation of $1 billion and I will own X shares that are worth 20 percent of the company”, then they actually own X shares that are worth 20 percent of that company. But if a private investor –

David:And if the price goes down or the company gets sold for $200 million, like tough luck. 

Ben:Yeah, exactly. You still own exactly 20 percent of that company. Whereas in the private markets, the reason or one of the reasons that we have always inflated valuations is because the risk that the investor takes by putting money in is dramatically reduced by the preference. So the way that that sort of works is you can say, hey, I'm going to take 20 percent of this company and give you $200 million and value you at a billion dollars. But if you sell for less than a billion –

David:For 500 million, I'm still going to take my 200 million back if you guarantee a return like the ratchet. It’s like, nah, I'm going to take my 200 million and I'm going to take a 20 percent return. So founders, employees, rest of the shareholders in the company, you thought you just sold for 500 million but you actually sold for whatever you call it, 200 million at that point. 

Ben:In this scenario, you take huge private round on huge private round and you build up all this liquidation preference, all this money that’s going to go to these investors that are happy to say, sure, we’ll give you a higher valuation because it’s lower risk for us. If you want that higher valuation, sure. But if things go south, then we’re going to get the money off the top before any of the common shareholders do. And so, you get yourself into the situation where suddenly have a $6 billion valuation, you start to realize that the public markets aren’t going to give you that $6 billion valuation because it’s a very different climate out there. You have a lot of people on that roadshow that you’re talking to that are all talking with each other. It's not a small conversation between a CEO and a few partners at a firm. It’s much more like it gets pushed down if there’s a narrative out there that wants to push it down. And so, I think depending on the story that's told when you’re IPO-ing, you can really get burned by that and that's what sort of Square was realizing, was uh-oh, we are not going to be able to IPO it at $6 billion or it's looking like we’re not going to be able to. There was like a 9-month period for Square where they’re issuing all these stock options as part of the compensation. So employees are hired in, they’re given 25% of their compensation in the form of stock options but it turns out those stock options have a strike price where the valuation of that company is $6 billion.

David:And today, the valuation is only 10. I mean, it's $4 billion higher but on a percentage basis, if you’ve got stock options, then it’s relative to the performance of the company and the growth of the company since then. You’re not really being rewarded for that. 

Ben:Right. And people started to sort of realize this where they’re hired in, they’re like, “Wait a minute. I'm never going to be able to,” or in any short amount of time, like these stock options that I was given aren’t going to be worth anything and so I'm being undercompensated for my work. So they start losing employees and if they go do another private round it’s going to have to be either a down round or a flat round, or if they go up then there’s even more liquidation preference that goes on top. And so they sort of have to go public in a lot of ways to get all that liquidity and make it so that when you issue the restricted stock units to your employees, like that that’s an option for you. I think they actually started issuing RSUs before they went public, but it was a little bit of like a too little, too late situation where you have all these employees over 9 months to a year whose stock options are worth nothing and realizing it. 

David:Yeah. Well, I think for me, this highlights when you’re talking about valuations of companies and investing in companies, and that's actually only part of what we do as startup investors, is as we’re talking on the Opsware episode, the most important thing is helping build companies. But, when you have your investor head on, that’s why you really need to value companies based on fundamentals. 

Ben:Which is of course so hard to do in the early stages, right? 

David:Totally. But by the time Square was raising these rounds, like it was possible. If you’re a founder in a company too, you also want your company to be valued on fundamentals. Taking a $6 billion valuation because you can get it and it feels good, it's like all nice and well. But you just screwed your employees, you know, if you take it with all this structure. 

Ben:And you know, we’re not accusing anybody of doing that because it’s one of these things where like the whole world is telling you yes and it seems like the train is going to keep going and then you’re going to IPO and you’re going to do another up round and it’s all just going to happen. But when you start reasoning from fundamentals, it does get a little scary. 

David:I completely agree with you, Ben. Like I don’t know the Square management team personally but I seriously doubt they were actively trying to screw their employees. 

Ben:No. They seem like incredible, incredible years and operators. So okay, we’re in What Would Have Happened Otherwise, and in thinking about that, one option and this is I think really hard to expect this of someone, but one option is back when they had I think their Series D that was Starbucks and Sacca was in the neighborhood of 3.5 billion, instead of that private round, they could have just tried to go public and doing that earlier might have been able to do a flatter or up IPO like at a higher valuation or maybe at that 3.5 billion valuation, at least up from their Series C from Kleiner Perkins, and it’s hard to do that because the business wasn’t as mature yet and it’s really hard to want to face that sort of public scrutiny. But as you say, the business was fairly mature then and their model was pretty... the fundamentals of the business has been the same for a very long time. 

David:Yeah. It would have been interesting to see if they had gone that path. I wonder though if the Starbucks deal was just too volatile at that point. And if they were still figuring out how bad it was. And again, good from a product and company building in a sense, but bad from a financial sense. I wonder if that's what held them back. 

Ben:Right. That's interesting. 

David:Well, there we are. 

Ben:There we are. 

David:That's why machine learning hasn’t come to startup management yet. 

Ben:Yeah. It really is. It takes being really hard in the weeds, doing the research on this stuff, being a venture capitalist, being someone with early stage shares or being a founder of a company that goes through many rounds of this stuff to really see how this plays out. I think you really see the value of experience. Like every time I look into one of these companies, my eyes gets opened by all the different scenarios that happened from staying private longer, from doing huge round, from really doing the math on what are all the possible outcomes. It’s just gotten hairier and hairier. I like the story that the very first term sheet was a two-line piece of paper that said “I will invest in your company for a valuation of this where I get this percent.” Like now, you go into an 8-page term sheet and then 100 pages of definitive docs and all these different terms, and the complexity has just grown exponentially in the last 50-60 years. 

David:Yeah. Which is not necessarily a bad thing. 

Ben:There’s a lot more at stake. Yeah. There’s tons of real value being created so it makes sense to have all these provisions and carve it all up.

David:But I think you’re right and I think this is actually moving into tech themes. I didn’t have this down but this is a great one which is just like just the value of experience and when it comes to startup management and startup investing and that could be a lived experience or synthetic experience. That's why we do this show. 

Ben:David and I are happy to get some synthetic experience at your expense.

David:Exactly, exactly. These decisions have a lot at stake and you can’t just devise an algorithm for the right way to move forward. The only thing you can have is experience and being thoughtful about it.

Ben:Good judgement, great people around you. 

David:What else you got for tech themes?

Ben:Boy, I really didn’t save much like I would. I mean, well, one thing that I will say and this might not be a tech theme, but it is incredible facing that tough period that they went through – a good amount of attrition, a CEO splitting his time while being another CEO, massively botched Starbucks deal. Through all this, they’ve really pulled out nicely. Like the company is in a pretty great place right now and it has predictable growth. They’re introducing new products to sell to existing businesses, and who knows, maybe they’ll move into a negative churn or maybe they already are a negative churn, who knows. But it is really a testament to a lot of the things they did right that they’ve got come as far as they have.

David:My tech theme I want to get in quickly is timing. And it’s funny. I feel like the timing of the IPO was so bad. I mean, we’re going to get into grading in just a minute here but man, they really messed up the timing on this one. But the timing of the company and the product, I think this is just a fantastic example of what we talk about a lot on this show of riding waves and timing those waves right. The growth in consumers wanting to pay via credit cards coupled with the growth in mobile devices, and right at 2009-2010 that creating this massive opportunity to disrupt the payments and the merchant industry, merchant services industry.

Ben:And just instant product market fit. Like, it’s so, so rare. I mean it’s like an iPhone style event that happens so rarely where something gets released and just everyone is like, “yup, nailed it.”

David:Yup, nailed it. All right, that's what I got for tech themes. Should we grade it?

Ben:Let’s do it. So I'm going to start from an A because it was like, we’ll start at the top, they needed cash, the future looked bright, they were near cash flow positive. I'm going to knock them down to –

David:Look, from a fundamental perspective, as we talked about, I think it was the right time to go public. They had ironed out the Starbucks deal, the future was bright.

Ben:Then I’ll knock it down to a B because I think they did it a round or two too late. Not only would the climate have been better to IPO but the fundamentals of the business would have justified going public earlier and it's a hard thing to expect of people but that knocks it down to a B for me. The whole Goldman Sachs thing, like unbelievable botch. Oh my gosh. If I was an employee, I’d be so infuriated and I think that for me, it’s a C. It’s a good idea that was at the wrong time with terrible execution. 

David:Yeah. Man, I'm so tempted to do like a Facebook IPO style grading here in that like I want to separate out the company and the performance of the company which I think is just fantastic. Truly, I think one of the best tech companies built in the past 10 years, one of the very, very best from the IPO execution. But I do think kind of like what saved the Facebook IPO for me and allowed me to give it two grades was I think they really learned and Mark talks about how like the IPO was a forcing function that really turned into kind of a company-saving event for them and realizing they had this huge problem with mobile. I'm not sure that the same thing happened with Square. I think they just kind of messed things up financially, as you were talking about, Ben. So I'm going to resist the temptation to do two grades although I do want to make it clear I have so much respect for Square as a company and as a company going forward. But I think the IPO process, I'm not going to be as harsh as you because again they probably needed the money and I think had they gone public earlier, they probably hadn’t had the Starbucks deal ironed out enough. That would have been a huge problem. So I'm willing to be a little more generous, but I'm going with B-. 

Ben:Well, you know, in this hypothetical world I can predict that it went well and it’s funny how like we only know how the exact reality played out. We don’t know how the alternative reality played out. So it’s not fair really to say that that would have been better.

David:All right.

Ben:I'm glad you didn’t give it two grades because I was going to rip on you pretty hard.

David:I could feel it coming so that's why I pulled back. 

Ben:It reminds of that Who’s Line is it Anyway? line where the show where all the facts are made up and the points don’t matter. It feels a lot like that. 

David:That's what we do here at Acquired. All right. Speaking of which, I know you all said you hate Follow-ups and so we’re just not going to do them, but in this case we have to say we were right. 

Ben:Yeah, we got to brag. 

David:We got to brag. Disney acquired a majority stake in BAMTech, exactly as we predicted they would. 

Ben:Maybe even sooner. I think we should go back and listen, but I think it was like sometime in the next year or two. But it was 4-5 months later. 

David:So good timing, Ben, speaking of timing.

Ben:And that's unbelievable. Like can we just rewind a second and think about like, holy crap, Disney is pulling all their content off of Netflix and doing a Disney-direct offering. It's their own streaming service through BAMTech directly to consumers. I can’t wait to see how this all shakes out.

David:Yeah, seriously. Future episodes to come. 

Ben:Well, yeah. Multiple. All right, Carve Outs? 

David:Carve Outs. Mine is so perfect for today. It combines everything we’ve talked about. So Nick Bilton who wrote Hatching Twitter, he was at The New York Times, now he’s at Vanity Fair, he has a great new podcast called Inside The Hive and he had Bob Iger, the Disney CEO on. And it was great. We’ll link to it in the show notes. But Bob talks about their M&A strategy and Lucasfilm and Pixar and Marvel and the Disney flywheel. It’s great. You guys will love it. I certainly did. 

Ben:Awesome, I got to check it out. So mine is a book that is currently being written but if you guys haven’t check out GitBooks before, it is really an interesting product. It’s like GitHub for books and you can sort of look at the contribution history and the revisions of a book while it’s out there in public. And you know, can be written and revised in real time for people to read it. It's a complete thing that you can go read but it’s interesting as the world changes. It continues to be rewritten. The book itself is called World After Capital and it is written by Albert Wenger of Union Square Ventures. It is so interesting. Like it is one of these things where you often get focused in your own niche or your own work and you read the things that are related specifically to your job, but you don’t think about of like the macro implications of what we’re all doing and it’s a really interesting book where he sort of argues that we’re moving past a world where capital is the expensive and scarce thing and that capital is cheaper than ever and it’s less meaningful than ever before and that knowledge– He talks about attention a little bit but really focuses on knowledge as being the scarce resource, and what does that mean in a world where knowledge is a scarce resource and he talks a lot about AI, machine learning. And if that stuff’s your jam and you like to be a futurist a little bit and have a little bit of sociology bent to it, go check it out. That is a really, really cool book and you can read it in pieces as you would expect from a nice web-based publication. 

David:That's awesome. I didn’t know GitBooks existed. I'm going to have to check that out. That's awesome. 


David:Well, that's what we got today.

Ben:Thank you so much to you guys for listening. Thanks to Perkins Coie, our sponsor for this episode. Check out the Slack Acquired.fm. We are nearly 900 and would love to have you join us. And lastly, pause this podcast right now and go leave us a review on iTunes. We really sincerely appreciate it. So, thanks everyone. 

David:Thanks everyone. We’ll see you next time. 

Episode 44: AOL - Time Warner (with the Internet History Podcast) - Transcript

You can listen to the episode here.

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Brian:So like a thousand dollars put in, dominoes at its nadir, has a better return than Apple. 

David:Wow. We’re in the wrong business.

Ben:I know.

Brian:Bottom fishing is a dangerous game though.

David:Yeah, yeah. 

Ben:[music] Welcome back to episode 44 of Acquired, the podcast about technology acquisitions and IPOs. I’m Ben Gilbert.

David:I'm David Rosenthal. 

Ben:And we are your hosts. So today, back by popular demand, we’ve got Brian McCullough of the Internet History Podcast on the show for a crossover episode. So thank you for joining us and hello, Brian.

Brian:Hi, guys. Popular demand? Are you sure?



Brian:This episode was one of the more popular ones of this year. Did we do the other one this year? Trust me, it’s in my top 20 for sure and I'm over 150 episodes at this point. 

Ben:Wow. Sweet.

David:Well, you are in our top 5, so...

Brian:I think the melding of the format sort of like makes all three of us up our games a little bit, you know.

Ben:It does. I think because it forced a little change for us. We were talking about this before the show, but listeners, David and I were talking about how we do our research for these episodes with Brian but knowing that he’s got such a clear narrative around it, we sort of just have this spew of facts and we can sort of play the role of “Hey, wait a minute. What about...?” instead of actually structuring the narrative ourselves. 

Continuing a little bit here about you guys probably want to know what the episode is about. So listeners may remember the last time we did this, in episode 33 with Overture’s acquisition by Yahoo and today we’re going back to kind of a similar time in a little bit before in 2000. We’re going to be talking about the sort of legendary, potentially the biggest flop of all time. A legend in the world of M&A, the merger of AOL and Time Warner in 2000. 

David:I don’t know if “legend” is the word I would use. 


Ben:Notorious, infamous. A cautionary tale. Maybe all of the above.

Brian:Well, let’s just skip to the end when we all say worst acquisition of all time. That’s the end of the episode. Thanks for having me here.

David:But today, we’re going to be looking at it from the AOL perspective. So, was it the worst of all time or was it brilliant? We’ll find out. 

Brian:Definitely have some thoughts on that.

Ben:So change in the format where David teases the audience into actually listening to the whole episode. 

David:Cue campy teaser now. 

Ben:Yes. Before we get into it, listeners, I want to mention we’ve got a Slack that is over 900 strong now. So if you like discussing M&A, IPOs, major tech news that happens, come join us at Acquired.fm and join the Slack. We also love reviews so if you feel so inclined, pop open Apple Podcasts, you actually can pause this episode right now and go and rate us on Apple Podcasts and it makes a world of difference. So, thanks to those of you who have done that and encourage more to do it in the future. 

And on to our sponsor. So our sponsor for this episode is Perkins Coie, the counsel to great companies. Today’s sponsor is with Jeff Beuche, the firm-wide chair of Perkins M&A practice. Jeff, what should tech entrepreneurs do in the period leading up to sale transaction to be prepared and positioned for a smooth process?

Jeff Beuche: So first, an entrepreneur needs to be honest with himself or herself about the company’s shortcomings. That could be a weakness in the business, a strong competitor, poor record keeping, maybe a deal that was cut that shouldn’t have been cut. Or some combination of those things. An M&A transaction tends to show a really bright on the company. The dents and dings will be obvious and buyers usually will raise them as issues. It’s best not to hide things or hope that they won’t be found. It’s better to think like a buyer, identify the problems, own them and be ready to discuss them and suggest solutions and mitigation steps. 

Ben:Well, thanks Jeff. Listeners, I recorded that audio before even picking this episode and it's oddly prescient on this one. If you want to learn more about Perkins Coie or reach out to Jeff directly, you can click the link in the show notes or in the slack. Thanks a lot to Perkins Coie for sponsoring.

Now, without any further ado, Brian, would you like to take us into the story?

Brian:Yeah. So, AOL - Time Warner, the notorious titanic of a specially dot com era shenanigans, we want to start with AOL because as I’ve learned by doing my show, people of a certain age have often said to me “Thanks for doing episodes on AOL because I kind of never understood what they did.” Which I get because if you’re in a time when the internet is all around you, it's in the ether, then “Oh, it was just an ISP, why are they still valuable?” They only ever had 25 million subscribers at their height. So, how does that compare to having billions of users like a Facebook has?

So, let’s start with AOL and posit that AOL over the course of the 90’s was probably the best stock to buy. If you were able to buy and it’s 1992 IPO and sell New Year’s Day in the year 2000, your stock would have appreciated 80,000 percent. At its height, its market cap was about 150 billion which was worth more than General Motors and Boeing combined. It was worth more than, obviously Time Warner, Disney, all sorts of people like that. 

It was estimated that more than 2000 AOL employees were on paper at least made millionaires by AOL stock. So you talk of a Facebook millionaire, even Microsoft millionaires, AOL made a lot of people on paper really rich. So AOL, yes, was an ISP. 

David:Back in our day, kids, you used to have to pay for the internet. 

Ben:And it wasn’t fast. And you couldn’t make a phone call. 

Brian:Or you couldn’t make a phone call because you had to dial in over your landline. Cellphones existed but most people didn’t have them. At their height, AOL had 25 million subscribers. That was 2002, so after, this merger takes place. But they were accounting for at various times 60 percent of US internet traffic in the 90’s. So there were other ISPs, even indie ISPs. But in the 90’s there weren’t cable modems, there wasn’t broadband. I mean, there was but most people dialed in and AOL was the main company that people dialed in with. AOL has a long, fascinating, tortured history going back to early 80’s. Again, I have a couple episodes on AOL that –

Ben:They’ve got some serious name changes, right? I mean, they didn’t start as AOL.

Brian:Yeah. Controlled Data Corporation. There was the Source. One man’s pivoting is another man’s failing at one business and jumping into another. You can look at AOL in two ways like either it’s one of the more tenacious and brilliant entrepreneurial stories because they basically lose money for the better part of 15 years, certainly more than a decade. What they’re chasing is the idea of online but they’re so soon and so early that they have to wait for the world to catch up to them. 

David:I think the other interesting thing to point out about AOL is it’s not a Silicon Valley Company. Its headquarters is in Dulles, Virginia. 

Brian:Exactly. Which isn’t even New Yorker, I mean it’s DC. So, right. It's not even because AOL, as we’ll talk about, it gets into especially Madison Avenue and creating content and Time Warner obviously, but they weren’t even New York based. They were in the middle of nowhere and everybody at that time always complained about that. Like, going to Dulles was like going to Siberia or something. 

So, again, we’re going to back to the ‘80s. It's not till the early ‘90s when they kind of tie themselves to Microsoft and Windows that they sort of leap to the head of the pack. There’s a whole pack here. There’s CompuServe, there’s Genie, there’s Prodigy. There’s all these. 

Ben:And Compuserve, so my dad was a beta tester for Compuserve and for AOL so we just got free accounts. I remember being on Compuserve and thinking it was better. But my understanding is that it was like only sort of for the super internet savvy nerds and AOL was much better at reaching the mass market. Does that feel like sort of why AOL won there? 

Brian:A hundred percent. AOL had the derogatory or pejorative name of “training wheels” for the internet. But they actually embraced that and it makes sense. I mean, I’ve said on the show like a lot of people’s first email was AOL in a time when you didn’t have email unless you were in a college or at work or something like that. But also, AOL trained people how to live online like they gave you a screen name and you went into the chatrooms and you did dirty sex chat and things like that. You could create an online identity. And this is what we should talk about, what AOL’s business was. They eventually basically made their money by allowing people on to the web, but they were also trying to curate the web and create this online experience that was like handhold people into it. 

David:That's really amazing. We’re kind of making fun of AOL in a lot of ways here for being a Dulles, Virginia company. Again, nothing against Dulles, Virginia, but not where you think of as a tech hub. But they really pioneered a lot of the paradigms of the internet that are some of the most valuable companies and products today. I mean, AOL Instant Messenger (AIM) was basically messenger. AOL was a lot like Facebook before Facebook.

Brian:Can we remember to bring that up at the end because, actually, AOL is always about to run out of money, perpetually. Because what they have to do in the early ‘90s is they create this it’s called a walled garden, so they go to people like Time Warner and they say, “Hey, can you give us Sports Illustrated content?” They go to this magazine, that newspaper and say, “Hey, we’ll pay you X millions of dollars. Allow us to republish your articles and your pictures and things like that in our walled garden.” And so, there’s all sorts of times when they get saved by an investment from this company or like call Allen, invest a lot but basically tries to take them over in the early ‘90s and they poison-pill him. Again, coming back to this idea that they were either not really a smart tech company or they were these insane scrappers that they held on this idea that online could be a thing and then position themselves that when the tidal wave came, they just rode it. I’ve talked again on the podcast before about reasons why Prodigy dropped the ball, CompuServe dropped the ball, AOL picked it up and ran with it. 

But essentially what you need to know is by 1996, essentially, AOL is the primary ISP but it also has this huge amount of content. So what you would do is you would dial in and you would be on AOL. You wouldn’t be on the web. AOL would give you your email, they’d feed you their headlines again, pegging the New York Times to provide headlines, that sort of thing. And then if you wanted to go to the web, then you bring up a browser or you’d go through them like it was a channel that you would go to. So it was always something that they were sort of wrestling with. Like they wanted you to stay on there in their walled garden, but then they also couldn’t help but be most people’s first introduction to the web and the internet, right? And they ride this through the ‘90s, through the –

Ben:They did eventually have a browser in AOL, right? 

Brian:Yeah. That's a whole another story about how they double-crossed NetScape and signed a deal with Microsoft. Then they had, because they had bought a browser called BookLink. But the point is, is that people aren’t sophisticated in ’96, ’97, ’98. For all they know, AOL is the internet. And so, when I say that they’re sort of wrestling with this, they want to be somebody who describes it as they want to be the carnival cruise lines for an online experience, so they want to curate it for you. But then at the same time, the reality is, is that most people getting on the web and doing things like going to Yahoo or whatever, are doing it through AOL and they can’t conceptually tell the difference.

Ben:I’d love to hold on to this until tech themes later but like, over and over and over again, the only thing that I'm thinking is bundling and unbundling. Like it is incredible how the entire internet, everything that we know as sort of the open web and various different protocols and things on various different platforms are all just bundled within AOL and they were basically making all the revenue for that for a very long time before we started to unbundle it all into these separate services. 

Brian:Now, there’s some also interesting things about AOL’s past which are not– AOL presented this sort of– Steve Case in his khakis in Gap ads, this sort of wholesome All-American thing. But they made most of their money by originally charging by the hour and most people were in the chat rooms doing sexy talk to each other, so in the background that's how they make their money. But also, they had a lot of things like accounting scandals where they get sued by even the attorney-general, like you’re not reporting – I can’t even remember the details, but they’re like reporting certain sales right away even though it should have been over time and things like that. So they kind of always were playing fast and loose but you can feel like, again, these are scrappers that are staying alive, staying alive with this dream of online becoming a thing until it finally is a thing. And it’s essentially ’96-’97 that it is a thing. And they wake up and they have 10 million subscribers that 60 percent of internet traffic is going through their pipes in ’98 or is it ’97, You’ve Got Mail - The Movie. Like again, we cannot underemphasize how much AOL was sort of the gateway for America embracing online and the web and the internet. They’re also on the web, they’re a portal like Yahoo is. By the year 2000, 4 out of every 5 web users were visiting an AOL property at least once a month. And they start to make real money by ’97-’98. So again –

Ben:When you say an AOL property, that’s on the web but something that's owned by AOL outside of the AOL walled garden? 

Brian:You know what, I pulled that out of my notes and I don’t actually know. But that's what I'm saying, is that they’re playing both sides of the fence. And we’ll get into like how they’re starting to make real money, like they would sell you, okay, beyond our AOL walled garden side or beyond our AOL.com side, they had all this stuff to sell. Actually, we’re going to get to that right in a second. 

So AOL starts to make real money in the dot com era and no one is making real money in the dot com era. So that's one of the reasons why their stock starts to go through the roof but then the other thing that Wall Street is seeing is, like, okay, this internet thing is happening and the majority of Americans are getting online via their pipes. So, what do you want to do? That’s the stock you want to be in. There’s a Henry Blodget quote where he says AOL is the blue chippiest of the internet stocks. They’re actually, you know, they’re the first internet company to be included in the S&P 500. Guess what company they replaced? Actually, there could be a million. It was Woolworths.

So, as late as 1998, they’re still under a $30 billion market cap but then like everything else in the dot com era, within 18 months that's ballooned above 150 billion. 

David:We’ve talked about this era on this show before and you certainly have on your show, Brian, but I think it’s worth, again, as always, just pausing on this like as late as 1998, AOL was worth a market cap of under $30 billion. 

Brian:And that was insanely expensive.

David:And that was insanely expensive. And then, 18 months later, they’re buying Time Warner and the combined company is valued over $350 billion. Like that is how crazy that moment in time was.

Brian:Well, let me tell you some more reasons why Wall Street was in love with AOL. What they’re looking at is, a lot of analysts call it like a three-legged stool or whatever. So they’re getting money from the subscriptions. Again, I think by 2000 they hit 20 million people paying $20 a month. And then, they’re a content platform. In the early days when they had to go to New York Times and say “We’ll pay you $2 million to get your headlines.” By ’97-’98, they can say to the New York Times, “You pay us. If you want to be in our walled garden, we’ve got the eyeballs, we’ve got the real estate. You pay us.” So they’re basically a content platform. That's very lucrative. But the big thing, and this is going to be key to this whole conversation, is that by ’97-’98, they’re making tons of money on advertising. Because, again, they’re basically where everybody goes, we think of people starting their day on Facebook now or whatever, so that's where your email was on AOL. By ’98-’99, that's where your buddy list was on AOL. But this whole concept of people starting their day online like AOL again sort of like trained people how to do that. 

So, I just did an episode with a Yahoo guy. All of the portals in this time period make money essentially by selling ads to other dot coms. The whole dot com bubble can be thought of as like just a snake eating its own tail. If you happen to be one of the portals though, you’re the one doing the eating and if you’re one of these venture-backed startups, you’re the tail. 

Ben:Which is so funny. I mean, the parallels to Facebook are just like jumping off the page, right? There was that era 3 or 4 years ago where everyone was saying that “oh yes,” Facebook discovered this magical mobile news feed ad and they’re mostly on this new format that’s to install apps and all the apps are funded by venture capitalist that are just paying money to startups to pay money to Facebook. It’s hilarious how it’s the same narrative around the company two decades later. 

Brian:Let me give you some brilliant examples of that. So, here’s a dot com company called Drkoop.com. C. Everett Koop was the sergeant general of the United States. This is how crazy the dot com era is. Doctorcoop.com is a company that IPOs to make a health website. I don’t know the date of their IPO. It’s probably ’98-’99. Definitely ’99 I think. They IPO and raise $85 million for their website. A month after they debut on the stock market, Dr. Koop turns around and basically spends all that money by agreeing to pay AOL $89 million over four years to provide health content to AOL users. So, all of the money they raise on their IPO, they turn around a month later and they hand it over to AOL. Because everybody thinks that AOL is where you got to be. And so AOL in 1999 is starting to ka-ching like crazy. Like there’s a company, a long-distance phone provider called Telesave that pays $100 million and this is playing off dot coms. Like there’s a company called Preview Travel that pays $21 million to be AOL’s online travel agent. 1-800-Flowers pays $25 million to be the florist. Although I had Jim McCann on the show and he said that that worked out very well for them. But AOL can play off Barnes & Noble who pays $40 million to be the bookselling partner in the walled garden section versus Amazon that pays 19 million to be part of the AOL.com web portal. eBay ponies up $75 million to be the exclusive auction provider. And it kind of works out for everybody. Like when Dr. Koop’s deal is announced, its stock actually leaps 56 percent in a day. This is the dot com era. But everyone believes that they have to be on AOL, just like everyone believes you’ve got to advertise on Yahoo or whatever. So, AOL is in this position to just start banking money, like all of a sudden they’re turning a profit where they hadn’t for years and they’re a meaningful profit and billions and billions of dollars. The guy behind this era is Bob Pittman. I don’t know if that name rings a bell to you, guys. He was one of the original founders of MTV. He became very famous for being the hard-driving guy behind this AOL deal-making machine.

Ben:He was their COO, right? 

Brian:I think so. Right. We’ll get to him later after the deal falls apart. Internally, his team of guys that would go around and shake the trees for these dot com deals were called the hunter gatherers because they “descended on the dot coms like scavengers and made them offers they couldn’t refuse.” There’s a quote where an anonymous dot com company says that it was like high pressure, boiler room type stuff. “For weeks it was ‘You’re great, you’re great, you’re great. We want to do business with you.’ And then one day, it turns out that we have to give them every last dollar we had in the bank and a 20% of our company.” Another dot commer says that AOL demanded 30% of her company “and then for good measure, they tell us ‘These are our terms. You have 24 hours to respond. And if you don’t, screw you. We’re going to go to your competitor.’” 

So listen, these are crazy times, these are fat times for AOL. Again, I want to bring up this idea of culture and AOL being scrappers and doing whatever it takes to stay alive. So why did they stop when all of a sudden they’re in the catbird seat. They seem to be the nexus of this new internet economy and Bob Pittman’s army of deal makers basically drive what is essentially the thing that really makes Wall Street go nuts. So we’re going to get into this again later but everyone thinks that AOL went away because people stopped doing dialup or paying for dialup and they moved to broadband and things like that. But the thing that we’ll see actually has the deal sort of collapse and AOL stock price collapse and things like that is the fact that what made their stock appreciate so much was that they would have this insane growth in advertising. That’s where the money was coming from. That’s where the actual cashflow is coming from. Sure, it’s great to have in the background this recurring revenue of the subscription revenue but that’s not what was actually moving the needle in terms of why Wall Street loves them. 

David:Yup. It was all these deals they were doing with all these dot com startups that were giving them all of their money. 


Brian:Well, interestingly enough to transition here, because they’re doing all these deals with these dot com companies, they have sort of their ears to the ground and they can start to see when the money starts to dry up, VC money starts to dry up, IPO start to go bust. They’re the ones that know before anybody else that listen, this bubble might be bursting. 

Ben:From like a sort of macroeconomic perspective, David, you may actually know more about this, like why are the VCs ceasing to invest there? What’s the signal to them to stop? 

David:It's hard to say. Again, because we’re talking about such compressed time frames here. If I were to speculate, I think it's probably just that so much money had gone into the system without real returns and so you start getting to the bottom of the barrel.

Brian:Well, actually, that's it. They got great returns. Again, there’s other things I don’t have in front of me with my notes.

David:Well, paper returns.

Brian:Right, right, right. But see, for them it doesn’t matter because anything can IPO for a certain amount of time. And so once you get past the lockup period, you can take actual garbage public and it doesn’t matter. Right?

David:Yeah. I was thinking more from the limited partner perspective. 

Brian:But what you said is exactly it, is that when they are taking garbage public, eventually everything is garbage and enough people have kind of gotten rich enough and fat enough that they’re like, “you know what, I'm going to sit these out.” The seventh pet startup, “I'm going to sit this one out.” My personal theory is that that was it. It's also a combination of people realizing that the returns on online advertising were not good. The click-through rates are plummeting so that’s always been such an underpinning of things. Ad rates underpinning, it’s sort of like the plankton and the sea or whatever. 

David:I guess that’s a key point too and I'm going to come back to it. I'm sure that had a lot to do with it too, is these companies that had been venture funded and then even IPO’d had given all their money to AOL and Yahoo and other portals and with the expectation that that would drive huge clicks and huge revenue. And then when it doesn’t then they go bankrupt and then there’s no more money to feed into the system. 

Brian:Well, it's the 1999 Super Bowl when I think there were 30 dot com companies, or maybe it was 2000. It makes more sense that it was 2000. That are paying $2 million apiece for your one Super Bowl ad and that worked out for certain companies like Hot Jobs, famously. But then others you’ve never heard of again and they blow their $2 million of the 10 million that they raised and, listen, there’s a reason why it’s called a mania. There’s a reason why after a party you have a hangover the next day because you did some crazy stuff. But that was the times. 

So to come back to this, as I said, they know before anyone else because they can see this. They can see, “Well, listen. Dr. Koop is not going to raise another round.” When that deal is up in three years or whatever it is, where are we going to get another Dr. Koop, right? So as early as and I want to stop and mention there’s three great books on this. It’s unusual that there’s been these many books written about a dot com era thing. There’s Kara Swisher’s book ‘There Must Be a Pony in Here Somewhere.” There’s Fools Rush in by Nina Munk. And there’s also Stealing Time by Alec Klein. So in one of those, you can see and there’s quotes from internal memos after other later lawsuits. As early as December ’98, internal emails show that like Steve Case and Pittman and the other lieutenants are kicking around the idea that they need to start thinking about a safe lily pad to kind of land this company on. Because they’re seeing the bubble bursting. And so this is December ’98 so it's still another 18 months before the bubble actually burst. So they think about other internet companies – and we’ll get into this later – but they seriously considered eBay. But Case was generally – Sorry, go ahead.

Ben:Didn’t they actually have Meg Whitman waiting in a room or something?

Brian:Okay, I’ll tell that story. 


Brian:Steve Case was wary of doubling down on another internet company because that makes sense strategically if you think the bubble is going to burst, why do another internet company.

David:Two anchors tied to one another are just going to sink faster.

Brian:Yeah, yeah. So he says something like let’s look beyond the internet and “identify companies that have a profound impact on how people get information, communicate with others which is our core business, byproducts are entertained, etc.” So, there’s major courtships within AT&T, the pre-singular merger AT&T. Disney, they went hard at Disney but apparently Michael Eisner was a hard no. And the quote, I think this is from Swisher’s book, one of the AOL guys says “We all knew we were living on borrowed time and we had to buy something of substance by using that huge currency. We didn’t use the term ‘bubble’ but we did talk about a coming nuclear winter.” Well, one of their problems is that they also know that dialup is a limited technology that’s going to be eclipsed by broadband. Again, they’re not stupid. As much as they’re not maybe a Silicon Valley company or a huge technologist, they know that broadband is coming either through DSL which people thought would be a thing at the time, but mainly cable modems. But a lot of thinking went into, “we should get a cable company.” Or, that’s probably they were talking to AT&T. AT&T had DSL at the time. 

Another quote from Kara Swisher’s book is an anonymous AOL guy says, “Cable was the driver of everything. Without it, no deal made sense.” So, Time Warner is the biggest of the media companies at this point in time. Also, they have a little thing called Time Warner Cable. So if Steve Case doesn’t want to do an internet tie-up, he wants something that has more substance. But no one is going to believe if they decide they’re going to buy an oil company or something like that. Though they could have. They have the market capped at basically by anything at that point. So what he believes as Time Warner has the content, and remember they spent a decade believing that content was the thing that would make it online become mainstream, become a thing. And so, content is key. How many times have we heard that over the decades? Time Warner has this Tiffany platinum content going back hundreds of years and by the way, they have a cable company. I think it was the third largest, maybe the second largest at the time. So, I’m going to take it aside here and tell you the story of Jerry Levin and Time Warner. Jerry Levin, the CEO of Time Warner at this point, made his bones through technology. HBO didn’t come up with the idea but he was the guy behind the strategy of “let’s deliver this pay channel via satellite TV.” He makes his name, rises up through the ranks via the incredible success of HBO. And Jerry Levin believed in technology because of that. In fact, over the several decades at the company, he continued to try to pioneer technological advances, believing that there is untold new ways in the future that technology is going to be able to deliver content and media and things like that. They invest in the full service network in Orlando which was sort of an attempt before the web took off to sort of do what they called 500 channels and shopping with your remote through your TV and things like that. It was at the time before they bought Warner, spent about a billion dollars on that. Also, when the web comes around, there is a site called Pathfinder that they throw several hundred million dollars after. I have a lovely episode on my podcast about Pathfinder because it's gone down the memory hole but it deserves to be remembered for all the things that it pioneered in terms of trying to deliver media on the web. But it also lost them a ton of money. 

Around this time, corporate America, there is a watch word, everyone needs an internet strategy. Disney does the Go Network. There was NBCI. There was all these initiatives that if you're a media company, you're trying anything you can do. Barry Diller tries to buy Lycos or was it Altavista, I can’t remember. Everyone thinks that you're going to be Amazon, you’ve got to come up with a way to either embrace the internet and the web or combat it or something. So you have Jerry Levin who’s always believed in technology that it's going to change content and media. Time Warner has failed time and time again to come up with an internet strategy. 

So in 1999 when the People’s Republic of China is having its 50thanniversary and all of the politicians and business leaders and specifically Davos in Beijing for that period of time. Everyone is in Beijing celebrating the 50thanniversary of the People’s Republic of China. Steve Case starts to seriously court Jerry Levin. Jerry Levin thinks, “this is great.” It’s going to prove him right that if he can marry the greatest media company in the world to what everyone believes is the greatest internet company, his vision of technology changing media will come true; this is going to be his legacy. 

In the various books it’s a complex courtship. This is where I believe the eBay thing comes in. My theory is that they kept talking to eBay because they were using it as a stocking horse. Like actually, I’m going to open up the Kara Swisher book here. The week before, and it might even be the day before, they actually announced the merger, the deal with Time Warner. Meg Whitman and their Goldman Sachs people are at AOL headquarters and they’re in one conference room, this is the main conference room, trying to work out a deal so that AOL is going to buy eBay. In what’s called the Malibu Room on the opposite end of the floor is Time Warner and their lawyers and they’re working on the deal that’s eventually going to go through. So it’s a comical thing, and this is quoting Swisher, “Executives are shuffling in and out, alternatively apologizing to and ignoring Whitman and her team who are sitting there cooling their heels wondering what.” They’re not quite sure what’s going on. Is this just the way AOL works? They’re famously flakey and like aggressive at various times, like sort of passive-aggressive almost. And so, spending day there where nothing really gets done and lawyers are running out of the room and disappearing and where are they going? They don’t really know. They don’t know that Time Warner is in the other room. So at the end of the day, Whitman and the team is leaving. She goes into Bob Pittman’s office to say goodbye and she says, “You’ve got a lot going on here, it seems.” Of course, she had no idea. I think it’s the next day that they announce the Time Warner thing. 

Now, this is definitely an aside. What if they had done the eBay deal? Because eBay survived the dot com bust better than everybody. 


David:Well, and in large part too because of PayPal, which of course came later. 

Brian:And then that’s the counterfactual if would AOL have been smart to have allowed the PayPal acquisition. But if you look at eBay stock, it goes down some but then it reaches its height. It surpasses its dot come bubble height in 2003-2004. It’s like the only stock that does. Like in a time period when Amazon is down to like $5, because eBay’s business basically never dipped, so in retrospect, which we’ll get into, buying eBay was the way to go. They should have gone with it.

David:I’m going to save this. I want to come back in tech themes. This is my tech theme here but this is, well, I’m going to say much more on this later. Suffice to say that eBay was the much better business for the internet certainly than Time Warner. 

Brian:Well, believe it or not, guys, I am going to wrap this up. Let’s do it. I promised 30 minutes, I’m way beyond that at this point. The deal is announced January 10, 2000. It's the merger of $164 billion AOL with $83 billion Time Warner. It announces a merger but the reality is that AOL shareholders controlled 56 percent of the merged company and Time Warner shareholders 44 percent, so it's an acquisition in all but name. I actually remember very vividly this happening and in my memory I forgot to look this up. Like Jerry Levin and Steve Case are on Charlie Rose that night, like they were everywhere. 

David:Charlie Rose. That’s great. 

Brian:Yeah. Steve Case vowed that one day, AOL-Time Warner would have $100 billion in revenue. It would be the world’s first trillion dollar market cap company. There’s a quote from Roger McNamee the venture capitalist who says, “Let’s be clear. This is the single most transformative event I’ve ever seen in my career.” Kara Swisher has a quote from her book where she says, “In one major move the two companies had seemingly addressed both of the their weaknesses and intensified their strengths. I won’t deny that I really believed that as did many others, many of whom now pretend they never did.” I mean, this is January of 2000. This is the height of the bubble. What’s also happening around this time, the Microsoft antitrust trial has come to an end. It looks like Microsoft is about to be broken up. Who looks like it’s the new king of the technology hill? It’s AOL of all people. What happens is, so the deal is announced in January of 2000. Four days later, the Dow Jones Industrial Average peaks at a level that it would not return to for more than six years. On March 10, 2000, the NASDAQ peaks at a level that it would not reach again until March of 2015, losing 80% of its value at its low. The bubble burst. And we’ll get into culturally why the acquisition was a disaster. The merger was a disaster. But again, the reality of it is not that people stopped doing dialup. Actually until 2002, the dialup subscriptions were still growing. It peaked at 26.7 million. The thing that kills this deal is that as soon as it happens, all of those deals that AOL did with the dot com companies disappear, evaporate. I’m not just saying that the three-year deal runs out. I’m saying that the companies are bankrupt and are not going to be sending you any more checks. So essentially, that insane growth in advertising that had so excited Wall Street, at some point Wall Street was estimating that AOL by 2003 would have more advertising revenue than in the ABC or a CBS in television. Like they’re thinking this is it, this is the next big thing. Goes away almost from the moment that the deal happens. Culturally, I don’t know how interesting this is but those AOL cowboys move in, they try to tell the Time Warner guys “Okay, we’re going to run this like a tech company now.” It’s like the host body rejecting an organ. Time Warner was always notorious for having these warring fiefdoms of “I control magazines. You control cable. You control book publishing.”

Ben:And not as similar from AOL. I mean, AOL had the internal fiefdom culture too. You mix two of those together, that can’t go well. 

Brian:Well, and then with AOL coming in as the conquering heroes and being like we know this new media game better than you yahoos.” But like literally --

Ben:You yahoos. No pun intended.

Brian:True. There’s practical things about culture clashes. In one of the books, like Sports Illustrated just refuses to play ball. Like we’re not going to give our content to you, we're running our own. In fact, with Sports Illustrated famously never really gave much to the web anyway. Or think of there’s a story about like Warner Studios after the merger refuses to let AOL take over the Harry Potter website and the online promotion. The Harry Potter movies are just getting going so that’s why Warner Studios -- So AOL says to them, “Okay, let’s take this over.” Warner Studios says no. And the thing that AOL wanted the most to save their skin was Time Warner’s cable division. Time Warner had Roadrunner famously, which is another thing. Like they couldn’t even get Warner to give them, license them the Roadrunner cartoon thing. That’s the in-fighting at Time Warner. So when AOL says, “Okay, listen, let’s brand AOL into your expanding cable internet service.” Time Warner Cable says, “Get bent.” Right? So even though they’re the acquiring company, essentially, the entrenched power brokers at Time Warner just tells these guys to screw off and basically waits them out until the disaster of the merger becomes evident and get kicked out. 

Ben:And if you think about like the power dynamics generated by the revenue, like I think AOL’s total revenue in 2000 right before the merger was like 9.5 billion or somewhere in that neighborhood. Time Warner had a much more narrow price-to-earnings ratio where of that, what were they valued at? Like 150 million or something. 

Brian:160 billion, yeah.

Ben:Yeah. Sorry, 160 billion. Like they had real material revenue such that had to be like a 3x or something. Not like a ridiculous multiple like AOL. 

David:Ben, I know what article you found because I found that one too. I think that was adjusted for inflation. But it’s even worse. AOL had less than 5 billion in revenue and Time Warner--

Brian:Right. It was that small. 

David:And Time Warner had over 25 billion. So over 5 times as much. And AOL’s “revenue” as we’ve talked about was the snake eating its tail.

Ben:As you can see how you're like a Time Warner mid-level exec and you still feel like you have all the power in that organization. 

Brian:Or you should by right. Think of this strategically. So, AOL thinks well, we’ll have a cable company and then that will solve our problem with the transition to broadband. But then if you're Comcast, why do you want to play ball with AOL now? Like if AOL had been independent, they were trying very hard to do things like go to Adelphia Cable or Comcast and say like, let’s co-brand AOL and we’ll take a certain percentage of the monthly fees. We’ll value-add to this. But once they’re with Time Warner, then why would any other broadband player play ball with them, right? So in a way, strategically, that never made sense. But then like we’ve been saying, essentially the money just dries up not again because of the dial-up subscriptions are drying up, but it's all of that ad money, it's all of that when they could charge the New York Times to be on their screens and things like that. It just evaporates in the nuclear winter of the dot com bubble bursting. And so, just a year, the one year anniversary of the merger being announced, the combined companies are only worth $147 billion. At the time of the announcement, AOL was worth $160 billion. So essentially, the combined companies a year later are worth less than AOL was at the time of the announcement. 

David:Yeah. And I think if they continued to go down from there, they go down below 100 billion, even I think below 50 billion for the combined companies. 

Brian:I had a bunch of stats on that too. The only thing that’s relevant I think is, it's because of the AOL side of the equation is delivering no profits and the revenues are shrinking and so Wall Street--

David:And they stole 55 percent of the company. 

Brian:Exactly. So the write-downs. $54 billion write-down, the company has to announce in 2002 which was the largest ever at that time. It might still be the largest ever, I don't know. 55.5 billion in 2003. The overall loss for 2002, this says it's 99 billion. So I don't know if that’s like a fiscal year versus calendar year thing. So basically, AOL, everything valuable about that company is completely an illusion and Wall Street notices. So, it’s announced, what is it, January of 2000. By December of 2001, Jerry Levin steps down. The AOL people are still thinking that they’re in charge at this point so they want to take over the CEO-ship of AOL, the control of AOL, specifically and actually that’s where Bob Pittman really was the guy that thought he was going to take it because he wasn’t feeling like Steve Case would step down at some point. But no, as we know, it went to Dick Parsons. And so Bob Pittman is out by July of 2002. Steve Case finally leaves in May 2003. September 18, 2003, Time Warner officially drops AOL from its name. The combined company was called AOL-Time Warner officially but just three years later, Time Warner basically wants to pretend like AOL never happened. 

Ben:At this point they still own the asset, like they’re not saying all in one fell swoop, “oh, we're going to spin it out.” Like they still own the company. They’re just not doing anything. 

Brian:Well, you always hear those numbers now and again about how millions of people are still paying every month for AOL dialup.

Ben:Oh yeah, I actually got the number. As of Verizon’s bid in May 2015, they’re still making $606.5 million in dialup revenue. I looked up some and it really actually hasn’t shrunk much today. They’re really actually maintaining that. 

Brian:Well, you know, there’s other assets and remember they bought Netscape? Only to --

David:A little company called Netscape.

Brian:There’s a reason why Kara Swisher’s book is called ‘There’s a Pony in Here Somewhere’. If there’s a mountain of s*** this big, there’s got to be a pony somewhere. They tried, man. 

David:It was a little pony. 

Brian:Well, actually it was a huge one and I’m glad you reminded me of this. I made a note. AOL Instant Messenger. At its height I think has over 100 million users. So like 2003-2004, people have a buddy list. It’s your social graph. For the research I’ve done on Facebook, basically they wrote Facebook. They didn’t talk to each other. They sat across tables from each other. They’re on AIM, chatting at each other. There’s quotes that I found like people in charge of AIM and things like that are like, “Yeah, we had social networking.” 

David:And again, AIM came from ICQ and which I think AOL acquired ICQ?

Brian:It didn’t actually come from ICQ. ICQ was another thing. No one knows why they bought it. AIM - it’s an interesting story - was an internal thing that AOL didn’t want to do, but like people thought it was cool. 

Ben:Why are messaging platforms always internal things? Slack, Discord, AIM that are like not actually going to be a product and then shocked, like we should be less shocked by now that messaging platforms make good spinout clients. 

Brian:And AOL should have known because they’re the ones that -- well, I didn’t say this before but the reason they beat Prodigy is because they let people chat. Prodigy tried to “don’t do sexy stuff”. So AOL became --

David:People want to do the sexy stuff. 

Brian:Just let people talk. The number one thing, if you have a technology product, a new technology paradigm, the thing that will be the company, the first successful company is the one that just lets people talk to each other. I guarantee you, the first billion dollar software platform or whatever company coming from VR is just the one that allows people to talk to each other in VR the best. 

Ben:Because there are real solid bets on that, yeah.

Brian:With the iPhone, what are the things that came through. Things like WhatsApp and things like that, yes. Any paradigm in technology allowing people to talk to each other is the safest first bet. 

Ben:I didn’t know that number, the 100 million number for AIM, but it makes sense. Like I had formative, formative, like growing up experiences where I had social -- like the first experience socializing with people. At least people online and also actually meaningful relationships. Even when you like went to the same high school or middle school, like we’d chat on AIM until like 2 in the morning and you get to know people and care about what’s in your profile and you care about Away messages. Like that was before Facebook wall posts. You have all these things where like it's social status, it communicates your personality. The number of people on your buddy list and the way you have it sorted is like representation of strong and we socialtize. Like that was an essential fabric of life. 

Brian:Well, you know, I would even say that same thing from the business perspective. My three startups were mostly in the 1999 to 2005 era. So before even Skype becomes a thing, like that’s how we did business, Skype-ing people all the time. If you know their Instant Messenger screen name, I’m going to talk to Owen Malek next week, but like he was famous for that. If you wanted to get on Gigaom, we were talking earlier about promoting startups and things like that, like if you knew Owen Malek’s instant messenger and I think Michael Errington was the same way, like that’s how you --

Ben:His was Skype, I think. I remember him being a huge… yeah.

Brian:Right. Business was done over that. Again, it's the social graph. It was your Rolodex, it was how you kept up with people. Yeah, it was everything. So I need to do an episode on that. I got to track down some AIM guys and have them basically--

David:Totally. It’s incredible. We joked about it earlier but like it was Facebook, WhatsApp, WeChat. All of this. Snapchat. Instagram. Well, not Instagram. Photos weren’t as big a part of it. But like all of the most important.

Brian:Oh, you could trade files. I don’t know if you remember that. 

David:You could trade music.

Ben:It would fail all the time. It was one of the things that it was like yeah, I’d give it a shot but we’ll see if it actually happens. 

David:For all the lots of people, ourselves included, make fun of these non-technologist cowboys in Virginia. Like they invented the internet, to borrow an Al Gore phrase.

Ben:It's a sad thing to watch really because Facebook was their opportunity to squander. It’s as you sort of study network effects and how people build defensibility around their business, there is some fascinating stories about I think it was ICQ trying to reverse engineer the AIM protocol so you can chat AIM people from the ICQ client and these basically engineering wars going back and forth of how could they keep tweaking the protocol to keep the other guys out and keep their network effect to themselves.

Brian:There was a whole Cold War between AOL and Microsoft because you had MSN chat, you had Yahoo chat.

Ben:Oh, that’s what it was. 

Brian:Yeah, that’s what it was.

Ben:MSN Messenger.

Brian:Right. As soon as MSN Messenger would crack the code, AOL would change it. 

David:And you saw these local network effect dynamics taking place, just like there is today. MSN Messenger and Live was the dominant network in a bunch of countries and AIM was the dominant network in the US. It’s just like iMessage and Facebook Messenger here versus WhatsApp in Europe.

Brian:Well, listen. Remember, Steve Jobs famously told us that they were going to opensource FaceTime.

Ben:FaceTime protocol. 

Brian:Yeah, I haven’t seen that happen. 

Ben:I think that’s actually less of a business decision and more of an engineering decision. I think as the lore goes, the team that built FaceTime was sitting in their row and they heard it for the first time when he announced it onstage and they all looked at each other like, “What?” 

Brian:I remember that too, yeah. Well, alright. I’m sorry I droned on so much. But I will hand the keys back to you, guys. 

David:Where do we even pick up? 

Ben:I know. Well, David, do you want to talk anything at all? Any more acquisition history and facts or should we go into the acquisition category? And I can kind of frame that up a little bit. 

David:The one thing I want to add, nothing more on the history and facts of this itself, but it’s just such a fitting quota to this whole story is history repeating itself again and look where we are today and AOL is owned by Verizon, AOL spun out of Time Warner in 2009. It was valued at just over $3 billion versus the astronomic heights of nearly 10 years before that. 

Brian:And that’s mostly because they had all this ad tech that they’ve bought over the years.

David:Yup. So they get acquired by Verizon and then on the Time Warner side, the deal hasn’t been approved by the government yet but they are in the process of getting acquired by AT&T. So there were all these jokes about the worst merger of all time and this tech internet company AOL merging with an old media company. And here we are in 2017 and both of them are owned by phone companies. Really, really hard to imagine. 

Ben:Well, for acquisition category, why don’t we actually take a stab from both directions. So let’s say first because it actually was AOL taking over Time Warner, what kind of acquisition was that for AOL? Our standard categories are people, technology, product, business line, asset or other. Brian, if I may be so bold as to voice what I think you would say, this is actually an “other” because it's not necessarily acquiring, if anything, it’s maybe acquiring a business line but it’s like acquiring stability and liquidity. It seems to be what you're implying. Like applying an exit strategy. 

Brian:See, here’s what I would say. The rationale is that they’re buying the business line or the technology. It’s murky to me what the category is. But they want the cable company so that they can transition into broadband. That’s their rationale. What are they really buying? The assets. They’re essentially trying to say, “Listen, if our stock is ephemeral, we need to convert it into something that will last forever.” Time Magazine has been around since the ‘20s. Warner Brothers has been around since the ‘20s. Like it’s the asset of content is king that they were really in their heart going after. 

Ben:Yeah. Well put. Man, and as a little aside, like if you are at the negotiating table there and you’re AOL, how do you keep a straight face through all this and really represent what you're in this for and what Time Warner is getting. 

Brian:We can get into speculating on that. 

Ben:Alright, I’ll save it. So then let’s take a stab from the other side. 

Brian:Well, actually, before you do, David, do you agree with that? What’s your take on it? 

David:Well, I think I would classify it as… I think you guys are totally right. To me, I would classify it as an “other” because I’m trying to wreck my brain here about any other deal we’ve covered on this show where the rationale for it has literally zero to do with the business. There is nothing going on here except it’s not an asset that’s valuable to AOL as a business. Certainly not technology. It’s not people. Business line, sure, but like it’s just tons of business lines there essentially buying a conglomerate. The only reason they’re doing it is to just sort of save their own net worth, personal net worth.

Brian:This might be a crazy analogy but the analogy that springs to mind is you know how like Dubai and all the golf countries, they know that oil is going to run out someday so they’re trying to turn into tourist destinations. So that has nothing to do with energy or natural resource but they’re like, “yeah, we know.” We got to do something that sustainable, you know. 

David:Yeah, exactly. And I think that’s what’s going on here. 

Ben:It's like Snapchat today if they were to decide to go buy land in Manhattan.

Brian:Right. Or an oil company. 

David:Which famously Zynga did when they bought their headquarters in San Francisco right in the heart of SoMa. It’s a huge building right across the street from AirBnb. It’s by far the most valuable part of Zynga. 

Brian:Well, the most valuable part of New York Times is their building. Or which, did they sell that already? I don't know. 

David:They sold it and they leased it back, yeah.

Brian:Got you. Okay. So let’s do do the reverse. So you guys go first then I’ll go last. So what is Time Warner thinking it's doing? 

Ben:So in my head, I’m wondering if they’re buying technology or they think they’re buying technology or it’s really buying distribution that like, say, they’ve somehow missed out on the internet and they need this way to distribute their content and it's much better to actually own it than to partner. And by buying AOL or by getting bought by AOL, then suddenly AOL has all these dialup customers, they’re in all these homes and they have a brand-new channel to get their content to them. I think if I was going to try and rationalize it from Time Warner’s side, that’s what I would go with.

David:I think there’s just some amazing quotes, doing the research here from all the principles involved and from media and observers at the time. But I think it’s kind of like Kara Swisher, you know, as you quoted, Brian, from her book, she’s the one who’s honest about this like, “Yeah, at the time people were riding high on something,” and they thought that this made sense. Jerry Levin, the CEO of Time Warner and then CEO of the combined company, he has this quote from when the deal gets announced. I think he said this to maybe there’s a big Washington Post article. I think it was in this. It might have been written by Kara. 

Brian:Yeah, she was with them at the time. 

David:Yeah. He says, “This new world of valuations in the internet economy is something I accept.” I mean, he’s basically saying like this company that’s buying us, like kind of has no business, I don’t understand the business, but like there’s the new normal. You know, that’s how people talked back then. 


David:So I think it’s just like, I don’t want to be too disparaging of them because really, as Kara said, like everybody believed it then. But like they drank the Kool-Aid. They thought that there was a new reality there. 

Brian:Jerry Levin bought the Kool-Aid. Which is why I’m going to make the argument that bizarrely enough for people, because that’s what he thinks. He thinks he’s coming to the end of his career, this is going to be my legacy. I was the guy that was smart enough to hitch this company to the thoroughbreds that are going to take it into the 21stCentury, right? And so, it's not people because he thinks that there these brilliant businessmen. It’s just that they have cracked the code of something that we old media people haven’t been able to figure out and we’ve been trying to do it for 10 years. So it’s people in that sense. 

David:And there’s such a great quote from Bob Pittman from AOL who they’re totally like the pushers, like just, you know, feeding more supply into these guys via mainline. He’s quoted in the press at the time saying that -- I think it might be from the same article. “The slow-moving Time Warner would now…” -- this is the author of the article writing -- “would now take off at ‘internet speed’ accelerated by AOL.” And then Bob Pittman comes in with a quote, “All you need to do is put a catalyst to Time Warner and in a short period you can alter the growth rate. The growth rate will be like an internet company.” This is like a --

Brian:It's alchemy. Alchemy via buzzwords essentially.

Ben:Here, David. Pass some of that over here. 

David:Totally. This is like the Beatles period when they went and lived in India and started doing their heavy drugs.

Ben:It does feel like literally nothing in that sense is grounded in reality. And you can understand in broad strokes how you look at a tech company and you look at the way that it grows. But like zero of that was connected to the intrinsic value and why tech companies get the multiples they do and why they have the growth rates they do and like any discussion of zero marginal cost, it's like, well, catalyst.

Brian:Can I make a point here? In my research of the dot com, the bubble generally, what you have to understand is everyone was saying “Okay, this is a bubble, this is a bubble, this is a bubble, this is a bubble…” from ’97 on, and kept being proven wrong. In my book, like there’s a thing where there’s quotes from bears on Wall Street or whatever, eventually everyone just capitulates because you've been wrong for so long. When you're like, there’s no way Yahoo is a $10 billion company and there’s no way they’re a 30. There’s no way there’s a 50. When they’re over $100 billion at some point you just got to be like, “well, s***.” And you know what, there’s all sorts of theory about bubbles and things like that, that that’s when the bubbles burst. When you finally slay the last bear, when people’s careers have been destroyed because they’ve been Cassandras for so long and it’s like, listen, I’ve been listening to you and I missed out on like a 500 percent upside.

Ben:So I guess I’m buying bitcoin at 4600. 

David:I was just thinking this whole time, this new or this will maybe transition to What Would Have Happened Otherwise, I would have loved to have had a conversation with Steve Jobs during this period and have been like, “Dude, what’s your take on this?” I can only imagine what he would have said. 

Brian:Yeah, I don't know. I have thoughts on that in the sense that because what happened in history is that they waited till everything exploded, there’s ashes on the ground and they sort of rise up in a place where no one thought: hardware. Or no one thought anything was going to be, everyone was going to be on the web.

David:But Steve is laying the groundwork for that all through this period. The next acquisition is at the end of 1996. 

Brian:And then they have that sort of that hub, the digital hub strategy.

David:Digital hub, yup, with the iMac. 

Brian:So they kind of do ride with the iMac.

David:It's when this is happening. 

Brian:Yeah, they do kind of position themselves as “we’re the best computer maker for this new web era.”

David:Well, we had a few counterfactuals throughout history and facts, what would have happened otherwise. But maybe a word on like what would have happened had these companies stayed independent.

Ben:Yeah. So the one thing that I really want to explore here, I think we could talk about AOL but I think my based assumption there is that it goes to zero or close. But the thing I’m curious about is, is Time Warner potentially, do they end up in a way better spot today in 2017 if they hadn’t gone through this? Or did this have some kind of positive effect on them that we really haven’t talked about.

Brian:They gained some DNA maybe or some thinking. Yeah, I don't know. Again, my most recent episode was with a Yahoo guy, you know, Yahoo surviving the dot com bust. Like they had the same issue of all of their dot com advertisers going away, so where are they going to get their money from and they basically Holloywoodized themselves, but they successfully turned the business around. So it’s almost like that idea of if you do have to struggle, you’re forced into creativity to find ways. So I’m not saying that AOL would have succeeded in anything. But maybe if they’re desperate, they do take a look at the one thing that’s actually still growing AIM and trying to figure out. It’s sort of like if you’ve got the parachute, then you just kind of enjoy the ride down and you're not hustling. 

Ben:Well, I think we covered the counterfactuals there. I don’t have anything else for what would have happened otherwise. 

David:Should we move on to tech themes?

Ben:Yeah, let’s do it. There’s a few that we’ve talked about but one that we haven’t talked about yet and that AOL is completely notorious for, is a lot of their rise and especially in branding and in brand recognition and then in distribution is really like one of the earliest internet growth hacks and that’s distributing the CDs. It’s doing something that other people aren’t to get noticed and to get distribution because the point I want to make here is, there’s a trick and then the earliest people make out like bandits and then everybody realizes what’s going on and then it becomes the normal thing and then there’s basically a CPM raise to the bottom and you're competing against everybody else in sort of a commodity, highly efficient marketplace. Like, if you're buying Facebook ads now and it’s not in any of the new formats, you're not jumping on whatever the new flashy thing is, like you can basically, depending on your category, understand what your cost of customer acquisition is going to be. And if you're AOL and you do a very brilliant marketing move of putting these CDs at the checkout where no digital company and really no company is doing their distribution,  like it’s in movie theaters, it’s in blockbusters, like all these unconventional places and you're giving away something, the benefit of AOL is 100 hours or 1000 hours for free, like there’s so much that they can give away for free because it’s the internet and it’s software and it’s reduced marginal cost relative to hard goods that it’s shocking to people. And for the first time, they’re like, “Oh my god, this seems like a crazy deal and no one has ever tried to reach me at this point before.” So to me, it's like a lot of times companies succeed because of the initial basically distribution or hack or I guess growth hack but really like figuring out how to get in front of people where no one else is getting in front of them. 

David:I love that image of like the, you know, Virginia suburbs, AOL and 80s and 90s guys being the original growth hackers. 

Brian:Mm-hmm. Well, hustlers. That’s what I always say.

David: Yeah. I mean, they’re definitely hustlers.

Brian:David, you want to do a tech theme?

David:Yeah. So mine, I alluded to this a little earlier but I think this episode for me is a great counterfactual illustration to -- I’ve been thinking a lot about this recently. What really is like the power of the internet, like this merger is getting everything wrong about the internet. What I mean by that is like the internet connects people. Brian, you were talking about AIM and letting people talk to one another and like how do you build value and create platforms on the internet like as we’ve learned over the last 20-30 years, like you let people talk to one another, you let people connect with one another. And AOL, instead of doubling down on that side of what they were doing, they doubled down and they bought a media company. The thing about a media company is it’s a manufacturing-based analogy. Like you're not manufacturing physical goods but you're manufacturing media, like you're making movies, you're writing journalism, you're making music. That stuff, you got to pay and make and sell. You can build great businesses doing that, of course, like Time Warner is a great business of not to knock it, but like that’s not the internet. What works on the internet and why the promise, the dream of the 90s was what has been realized now which is Facebook, Google, YouTube, Airbnb, Uber, Twitch, Amazon. Amazon originally wasn’t this but now is this. They don’t make stuff. Like they connect people. 

Ben:Facebook is a bundle of content and they don’t pay for any of it.

Brian:That’s exactly what I was going to say. So what actually succeeded in the next decade, it was Facebook and Google who essentially make money off of everybody else’s content by doing nothing. Well, I mean, they sell the ads. They sell the ads against it and they’re the platform that people find it. Essentially, where do I find my Sports Illustrated article or my whatever in my Facebook feed or I do a Google search for something and some evergreen article from somebody’s website. But right, so AOL is going after the content because they think, well, that’s the evergreen thing. That’s the actual value. 

David:Right. But they’re getting in a worst business by doing that.

Brian:And the value of that content has been completely undermined because of what the Facebooks and the Googles did. Now, thinking about that, why is everyone getting into content? Why is Apple going to buy James Bond?

David:Yeah, I don’t understand it, honestly. 

Brian:So either we’re not smart enough to know how the worm has turned or people are making similar mistakes or what, because we’re now entering an era where Twitter and NFL Games on… like, what is it? Is content valuable or isn’t it? 

David:I don't know. I guess the only thing that I’m not smart enough to opine, although I think back to our episode on BAMTech, which was really fun to dig into, these companies, the Apples, the Amazons, the Facebooks, they’re a little bit playing a different game now that they’re so big. They are so big they have so much money and I think a little bit they’re playing defense versus offense. That’s something we’ve talked about on the show. Like, defense in that like they want to keep people, they need to keep people on their properties. That’s how the merry-go-round keeps spinning and by going out and buying these super expensive manufactured content, I think the hope is that that will attract and keep people on the platform. That will attract people or retain people on the platform and then they’ll stick around for all the stuff they’re not making which is making the wheel-ground. But if they move to a paradigm where they’re paying for all the content on their platforms like that’s a worst business.  

Ben:I think there’s like a tick-tock thing here where first, everybody is free and open about their content being aggregated because, I mean, if you just look at what Disney was doing for the longest time, they’re like, “well, we create content and it needs to be viewed everywhere because we’re horizontal.” So then they spend 5 to 10 years executing that strategy and then suddenly the world starts to change and people start locking up their content vertically integrating and then you're like, “well, okay, now we need to change our whole strategy” and own every dollar that comes from serving our content. It's the aggregators that lose out in that world where the content starts getting locked up and so when you see an Apple or a Netflix or any of these, Netflix so much more so because they started as a pure aggregator. You need to make your own stuff because if everything is living in silos you got to have a good silo. 

Brian:The history repeating itself lesson is that Yahoo, this is going back to our previous episode we did together, Yahoo and the portals wanted to keep everybody on their pages. Google found a way to make money by being like “No, leave our page. That’s fine. We’ll still make money off you.” So the question actually is, is that a dead paradigm? Is the open web a dead paradigm? Because if it is, then it’s all walled gardens all the way down from here on out. 

David:It's turtles all the way down. 

Brian:Turtles all the way down or is that sort of freedom of digital makes everything a commodity something that always comes back and rears its head. 

Ben:No. I mean, high quality content is very expensive to make and very valuable. It’s only gotten even more magnified in this world where everybody is talking about the same thing at the same time.

Brian:They’ve been saying content is king since the ‘90s, my friend.

David:Yeah. Well, but I think it is like the promise of the internet though. I don't know, maybe we are talking back into a world where content is the most valuable. But what Facebook and Google and others proved is like before them, content was king but it’s not king anymore. Like being the platform is king. That’s not the same as distribution. Like it was always content is better than being the cable company, the downpipe, right? But being the platform where you control the user experience and funnel, you control attention, that’s better than making the content. 

Ben:So it’s the newsfeed versus the, you know, I’m thinking about it like rather than me having the choice in my RSS reader of choosing from any of the feeds I subscribe to Facebook slams something down my throat and I say like, “Yup, I’ll read that.” So if you're having an RSS feed --

David:Because then you’d get all your feed from Facebook. 


Brian:I don't know. Sharp listeners, we might have all argued both sides of this. 

David:We might have, yeah. 

Ben:But David, I’ll give you credit for that point. I’ve never thought about that before, that distribution is if you're going to make a line and say content or distribution, there’s something sort of different in being one of these platforms that dictates where your attention goes. 

David:I’ll use another analogy before I give up the ghost here. Airbnb. The analogy would be like it would be great to be joie de vivre or a boutique, really high-end hotel chain, like you do really well, you make money. But like it’s way better to be Airbnb because then you don’t have to make the hotels, you don’t have to build them, you don’t have to run them. But you can access everybody and you can open up all this new supply that didn’t exist in the marketplace before. To me, that’s the dream of the internet, going and buying. You know, if Airbnb were to go and buy the rights to list Fairmont or Ritz Carlton hotels on their platform because it’s super premium, super exclusive content that seems odd.

Brian:So again, I’m confused that we’re arguing that content is…

David:Well, I’m arguing that content is not king. That’s what I’m…

Brian:Okay, got you. Yeah, I don't know. You guys are still in this game. I’m not. 

Ben:I withdraw formally. 

David:All right, this is great. This is our first like -- not first, but in a long time real debate on Acquired.

Ben:Wait, Brian. Do you mean because you're an author and a podcaster now…

Brian:I’m an author now. I’m moving on to being a historian author. Yeah, exactly. No more stars for me.

Ben:Then I just withdraw from this specific argument.

David:All right. 

Ben:All right. So moving on to grading, the funniest part about this whole thing is since AOL is actually the acquirer, like what I thought I was going to grade, I came into this thinking like, well, this would be a fun first F. But for AOL, I mean, it’s like an A-, right?

Brian:That’s the question. Okay? And anyone that has access to a Bloomberg terminal, like I do not, I don't know that anyone’s done the math on that. So if you're an AOL shareholder and you have 10 shares before the acquisition, before the merger, what is the value of that and then what is the value save of the day that they remove AOL from the AOL-Time Warner name. Now, it’s got to be less. We know what, right? But how much less? Then if you compare that to like the counterfactual of if they had never combined, would AOL have gone to zero? So is it actually a success? There are lots of people. You read these books, you get the quotes from the Time Warner insiders, they absolutely believed this was money laundering. They absolutely believed that they got held up. The AOL cowboys come in with their hugely valuable stock, they laundered it into this actually valuable Time Warner stock and they got away with the heist, essentially. That’s the view of a lot of Time Warner people. But I actually don’t know the math on that and if someone can do it, like so even if that ten shares of AOL, even if it only goes down by 60 percent, that’s better than going down 99 percent, right? So, is it actually a success? 

David:Yeah. Well, I mean, I think so. On the one sense you could look at, without doing the math on share prices and holdings, if AOL was worth whatever it was, 200-ish billion before the merger, and then ultimately got spun out of Time Warner at a value of 3 billion and got acquired by Verizon for 4.4 billion in 2015 or whatever it was. Okay, so that’s like a huge loss in value. 

Brian:But you still had your Time Warner shares.

David:Right. But instead, you got shares in AOL-Time Warner and then after the spinoff you kept your Time Warner shares and Time Warner just got acquired for or is in the process of getting acquired for about 85 billion dollars, I think.

Brian:That’s the math you got to do, yeah.

David:So you now have joint about 90 billion dollars versus 5. That seems good if you were an AOL shareholder. I mean, of course you should have just sold at the top and put your money into Amazon or Domino’s Pizza.

Brian:Or Priceline, Domino’s Pizza, yeah.

Ben:That’s right. I was going to say the only way this could be better for AOL is if they actually bought a growth company like eBay. 

Brian:Yeah. That could have been a win. But then, like we said, listen, the cowboys come into eBay, tell them how to run things, would they have been smart enough to buy PayPal. PayPal was the real valuable business there. It's got to be an F, guys. There’s a reason that people call it the worst merger of all time because it destroys, well…

David:So much value. Well, it destroys a ton of value for Time Warner, for sure.

Brian:It destroys $100 billion worth of value in the end. 


Brian:But the problem is, was that all from AOL? 

David:It feels crappy to consider giving them an A just because like the AOL management team and shareholders save their own personal wealth essentially. 

Ben:Well, but isn’t that what we grade on? Was this a good thing that for the shareholders of the acquirer?

David:This is good. Shareholders, or is it a good thing for the business. Terrible for the business, good for the shareholders. What do we do?

Brian:It's better for the acquiring shareholders than it could have been. It’s bad for all of the shareholders involved in the end. Because essentially, AOL is a sinking ship that just grabbed another ship and brought it down with it.

David:And didn’t sink as far because of it.

Ben:Slower, yeah.

Brian:You don’t reach the bottom but you're still underwater. There’s got to be 30 Harvard Business School case studies that are telling us that it has to be an F. If this is the first F, if you're ever going to give an F to something in this show. 

Ben:There’s also got to be some nice case studies in some sort of like business epistemological thought. I don’t even know if that’s the right word that I’m trying to think of. But basically around that question David just asked. Is it the shareholders or is it the business? And David, is there a difference?

David:Well, corporate behavior of the past, 50 years would imply no. But I think if you look back farther in history than that, there absolutely is a difference. 

Brian:If you can’t save the patient, you know, like -- but like if the enterprise itself dies, so keeping the enterprise itself alive even in some sort of mutated form is valuable.

David:I guess.

Brian:Because if the patient is dead, they’re dead.

David:Well, it’s sort of like, I think what we're coming to here and we have been for the whole episode is like exactly what you said, Brian. Like they were drowning and they grabbed a life vest and that kept them from drowning. On the other hand, it didn’t get them to shore. They didn’t catch a boat. They grabbed like a piece of driftwood. I think I’m ready to put forth a grade. I think I give the acquisition a C for AOL shareholders because of that. Like yeah, you did keep the business alive You preserved shareholder value relative to the alternative. But relative to what our two best acquisitions of all time on this show that we’ve rated thus far, NeXT and Instagram, like those are businesses that, to use Bob Pittman’s drug pusher-like analogy, accelerated their company, their acquirers at internet speed. Like there was no acceleration happening here. There was just buoyancy. 

Brian:I’m going to do F because if there has never been an F on this show, you're never going to get a better chance. No one is going to begrudge you giving this the F. 

Ben:Like we kind of set a bookend, set the scale. 

Brian:Listen. Yeah, the scale doesn’t have any meaning unless there’s a top and a bottom. 

David:Well, if it were Time Warner acquiring AOL, absolutely F. No question about it.

Brian:I do have sort of a logical reason for it which is that, again, it's sort of what we said about what happens in the next decade. Like, being in the magazine business, being in the television business, being even in the movie business was not actually the evergreen thing. They didn’t grab something that turned out to be the thing that, look, movie attendance goes down, television watching goes down, magazines are basically on life support, newspapers are essentially dead. So this idea that they jumped into media that would always be valuable was not right and they were a part of the disruptive force that made that happen. So this plunges back into this argument about the value of content and things like that. But I think it's a bad thing because in the end, I would view it as two doomed businesses. Or not doomed. Let’s say extremely challenged businesses. So embracing each other and so a successful “get out of jail” by AOL would have been a better company, an eBay or something. But would have been staying independent, struggling. What’s the one thing we’ve got? It’s AIM. So the failure is two companies that were going down embracing each other. So it’s bad to me because they clung on to the wrong lily pad. How many mixed metaphors can I do? 

David:Love it, love it. 

Ben:Well, I was trying to think what would my F be. I think an A is a business is dying and acquirer is something and then can become the most valuable business of all time, so that’s Apple. I’m sorry, an A+. Then an F would be a company is the best business of all time and acquirer is something and that acquisition manages to sink it to zero.

Brian:Bankrupt them. You're right, you're right.

Ben:Yeah. And so, with our scale it’s almost sort of logarithmic toward the top because we often are like, well, we gave Instagram an A, so this thing has to be like a B+. And like, there’s very successful acquisitions that we don’t give A’s. I think like I’ve given and we may have to go back and revise at some point, but I’ve given YouTube a C because like I was worried about the opportunity cost of focusing on that for Google when it was a breakeven business. So to me, while I don't know if I could go F because AOL didn’t completely crater their own business by making this acquisition, I don’t think I --

David:But Time Warner did. 

Ben:Time Warner did but they are the acquiree. I mean, I would have to go like D or D- because I think had buying Time Warner destroyed AOL, then it’s an F. But it’s certainly worse than a C for me. And way, way worse. So I’m going to go with D- and I hope to one day find something on Acquired where something went from like a Fortune 10 to destroying themselves. I don't know. But if we ever have an F, that’s what it would be. 

Brian:Like some company that buys something that causes cancer for $10 billion. Which actually, I shouldn’t joke about that. That’s probably happened or something. Well, all I want to do is as long as this show goes on, I’m the one that first gave an F. Let’s put that in the record.

David:Great. You're forever, you know, you can put in your trophy case the original --

Ben:We’ll change the Twitter bio. 

David:Yeah. The original F. Carve Outs?

Ben:Carve Outs, quick, yeah.  So mine is a book that I’m almost done listening to on audiobook and I’m going to be really bummed when it’s over because it’s really nice to have a dose of this kind of reminder in my life every day on my commute, and that is, Give and Take by Adam Grant. It’s really making the rounds right now so I’m sure a lot of listeners have already heard of it or had people tell them they should read it. It’s so awesome. It’s research-backed descriptions of the behaviors of givers, takers and matchers in our lives and what the results are of those personality types, and a litany of examples of givers and what they’ve done and how they’ve succeeded in their careers. The super interesting thing that pops out from the book is if you look at sort of a spectrum of people’s success in their careers, takers, if you look at a span from 1 to 5 where 1 is not succeeding at all and 5 is succeeding fantastically, takers occupy 2 and 4, matchers occupy 3, and givers occupy 1 and 5. So it’s this interesting dissection of just by being a “give first” person, it doesn’t guarantee that you're going to end up on top or bottom and it tries to sort of tease apart what are the traits of givers that can make you someone that ends up ahead in the long run just because you truly care about people and you're truly someone that looks out for the interest of others and it’s interesting to understand something that I never had a mental structure for before. And it’s also like a good little kick to be a better person and it's nice to have that voice every day. And the narrator sounds like Craig Federighi, so if you like watching Apple Keynotes, you’ll like listening to this guy’s voice. 

David:My carve out which is appropriate for this episode with Brian and the Internet History Podcast and has been a deeply historical episode, another book, a great one that I’m also a little over halfway through reading and can’t wait to finish called Season of the Witch and…

Brian:I have that on my Kindle. I haven’t read it yet.

David:You’ll love it. It’s the dark history of the dark side of the counterculture in San Francisco and what happened to San Francisco in the 60s and in particular in the 70s. The Manson Murders, the Zodiac Killer, the zebra killings. Everything that was really the not-often-told. We remember the 60s as like peace and love and it’s the 50thanniversary of the Summer of Love in the city this summer. What gets celebrated is the happy, the psychedelics but there was a true, true dark side and it's very, very fascinating to read about. And really shaped the city and again like we’ve talked about on this podcast too, it was the tech movement in Silicon Valley that really came out of the next period in history in this area and it was shaped by the dark side as well. 

Brian:Is the tech angle in the book? 

David:Not thus far. I don't know because I haven't gotten to the end yet. So I’m curious to see. But I’ve also started reading another book called What The Door Mouse Said which you've probably read.


David:Which is about the tech angle in the 60s, in the counterculture. 

Brian:I just watched for the first time recently the Zodiac movie, David Fincher’s Zodiac. I had always heard it was a good movie but I tend to avoid serial killer movies. But that really is a good movie. I was going to do a book anyway so I’m not going to buck this trend. Claude Shannon, people might know from the book The Information but also basically the guy that invented information theory, Alan Turing knew the dude, like he shows up in the intersections of all sorts of things with computing and the internet and things like that. I think it's the first full comprehensive biography of him. It’s called A Mind at Play: How Claude Shannon Invented the Information Age, the authors are Rob Goodman and Jimmy Soni. I have not read it at all but it is the top of my list to read and so I think since that’s my sort of gig, is the history of technology and things like that, I’m eager to learn about the minds that shaped information technology and Claude Shannon. If you've read the information, you should know about him, basically formulating the theory behind essentially coding and how logic goes into programming and things like that and taking it from the philosophical into the practical. So yeah, I haven’t read it yet so I can’t say that it’s great but I want to know more about Claude Shannon and you should too probably. 

Ben:Well, that’s it for our show. One thing I forget to mention earlier that might be interesting to listeners is we spend a couple of episodes asking you guys to fill out a survey and we posted the results on Acquired.fm/audience. So if you’re interested, we’ve got some interesting stats on there. Two-thirds of our audience is based in the US. Twenty-four percent of you are engineers, 26 percent of you are currently or have started a startup and there’s loads of other good information on there. So if you're curious about basically Acquired’s listenership, check out Acquired.fm/audience. 

David:And one more bonus/super carve out for the end of the episode is of course the Internet History Podcast. As we have told you guys many times on this show, Ben and I are both huge fans, Brian, of your work. It’s awesome and this has been so much I think even more fun than last time having you on the show. 

Brian:I think we got to know each other like I totally was so geeked to do this because I was like, okay, I think we’re good together. So I knew the rhythms and I was like, “Oh, this is going to be great.” 

David:The peanut butter and jelly of tech history podcasts.

Brian:Well, thank you and since I’m going to just basically post this on my site completely unedited, I promoted it last time. I got feedback, a bunch of you listened and subscribed and you can hear that these guys are smart and they come at it from a different angle than I do and it’s fantastic. Acquired.fm, right? 

David:Acquired.fm on the internet. AOL or otherwise. 


Ben:AOL keyword Acquired. 

Brian:I was going to say they used to have keywords. You could buy keywords. Like literally if you wanted books, you didn’t have to -- it wasn’t Google Adwords or Adsense, it was literally you would type books into the AOL search bar and they would give you not web pages but just what they had in their system in terms of books. You could buy that keyword. I think I did it once actually. 

Ben:Well, guys, that’s it. If you aren’t subscribed and want to hear more, you can subscribe from your favorite podcast client to Acquired or the Internet History podcast and if you feel so inclined, we would love a review on iTunes. Have a great day!

Episode 46: Blue Bottle Coffee - Transcript

You can listen to the episode here.

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)


David:  It can’t be turtles all the way down. There has to be a pool at the bottom. 

Ben: Oh man, I’m using that as the teaser quote for this episode. [music] Welcome back to Episode 46 of Acquired, the podcast about technology acquisitions and IPOs. I’m Ben Gilbert. 

David: I’m David Rosenthal. 

Ben: And we are your hosts. Today we are covering an acquisition that the tech audience cares a lot about even though it’s not really a tech company: Nestle’s acquisition of Blue Bottle. 

David: Shockwaves have gone through Silicon Valley.

Ben: Yes, yes. There have been lines around the block that are forming their own lines around the block just to hear the news. 

David: So great. Where will the VCs and entrepreneurs congregate now? 

Ben: Yeah. I mean, what’s the sort of like islandish one? 

David: Phil’s.

Ben: Phil’s. Fourth wave of coffee.

David: Fourth wave. We’ll get into it. 

Ben: We will, we will. Our sponsor for this episode is Perkins Coie, the counsel to great companies. Today’s sponsorship is with Jeff Beuche, the firm-wide chair of Perkins’ M&A practice. So today’s question is a little bit of a deeper topic but super applicable if you're getting into sort of a serious state of mind about an upcoming M&A transaction. So Jeff, what are you seeing as the most disruptive trend in M&A right now?

Jeff Beuche: It's for sure representation and warranty insurance. That’s an insurance product that either a buyer or a seller can purchase to ensure losses associated with breaches of reps and warranties. The use of rep and warranty insurance is widespread in the private equity industry and has fundamentally changed the way that those parties approach purchase agreements, impose closing recourse negotiations generally. It's a really powerful tool for resolving some of the hardest risk allocation issues in a deal. We haven’t seen rep and warranty insurance widely adopted by strategic buyers or in the tech M&A world yet, but it's a revolutionary product that we do expect will be used in most deals in the coming years.

Ben: Thanks, Jeff. If you want to learn more about Perkins Coie or reach out to Jeff specifically, you can click the link in the show notes or in the Slack at Acquired.fm. All right. Well, David, that’s all I’ve got for pre-show. 

David: All right. Well, before we dive in, I was thinking about this episode and it’s kind of funny. We’ve got this series of like miniseries here on Acquired. We did the Disney trifecta and then the fourth of course with BAMTech. We’ve done sports, we did the LA Clippers. That was out there but fun. We’ve done a bunch of gaming episodes. And now, we’ve got our second coffee episode on the heels of the Starbucks episode. 

Ben: Well, this is a primarily Seattle dominant podcast, so we do have to do multiple coffee episodes. 

David: The next one, we’ll have to do the Seahawks next. 

Ben: Yeah, yeah. 

David: So, coffee. We talked quite a bit in the Starbucks episode with Dan Levitan about waves of coffee and the parallels between the coffee world and the tech world. We alluded to Third Wave coffee which really is kind of the reaction to Starbucks, Starbucks being Second Wave. If the First Wave was kind of Folgers and Maxwell House and brew-at-home coffee, the Second Wave being Starbucks, an experience, a place you go to. The Third Wave is really all about the quality of the coffee. It is really the origin of hipsterdom. “Starbucks sucks. It’s super corporate. We're going to focus on the artisanal quality.”

Ben: And the coffee is burnt, it’s dark. No care put into it. It’s a factory. Everything is made exactly the same. Call it operationally efficient and praise their business model. Or, hate on it because it’s systematized. But it is definitely, definitely a reaction to the mass market success of Starbucks. 

David: Yeah. And so, Third Wave places like counterculture was one of the first in Durham, North Carolina, Stumptown down in Portland, which is now owned by Pete’s, interestingly. Or Intelligentsia which I think started in Chicago is also now majority-owned by Pete’s. Caffé Vita in Seattle, all these folks. They really focus on the drink itself and probably, arguably, nobody focused more on the drink than Blue Bottle. So let’s dive into Blue Bottle.

So it was founded by a very interesting, interesting guy named James Freeman. And I highly recommend, we’ll link to this in the show notes but he did the Stanford Entrepreneurial Thought Leader talk; he gave a talk there last year. Really fun to listen to. Basically, let’s just say he starts it with an analogy to Merce Cunningham and John Cage, the sort avant-garde, modern dance choreographer Merce Cunningham and his partner John Cage who is an avant-garde musician. They worked together as an analogy for his whole talk and then he goes on to quote Sartre and Proust. Very philosophical. 

Ben: Honestly, David, one of my favorite things about this show is learning about the insane and talented and driven people that start these companies. There are no normal people that start enormous companies. 

David: No. And James is no exception. Unlike most of the founders we talk about, he is definitely not an engineer. Not even remotely connected with the tech world except for the fact that he lived in the Bay Area. He was a freelance clarinetist, a classical musician who played the clarinet, and he did that for until his mid-30s. Then he kind of woke up one day and he realized, “You know, I’m never going to be the best clarinetist and maybe I should find something else to do with my life.” And what else could he do? Turns out, he had this side hobby of roasting his own coffee beans in his oven at home. So he would buy beans and he would roast them at home in his kitchen in his oven. Apparently made lots of smoke and his wife at the time was not a fan of this hobby. But he made these beans and then he would drink the coffee himself and he would give it to his friends and people loved it, and he thought, “Well, maybe I’ll turn to coffee for my life.”

So he started in the early 2000s, he quits the music world and he lived in -- I don’t know if he actually lived in Oakland or if he started the company in Oakland. He was living in the Bay Area. Starts Blue Bottle in Oakland and the original business plan is that he’s going to keep doing what he’s doing and deliver beans to people’s houses, these great beans that he’s roasted in his kitchen the day before, will deliver them to his friend’s houses. So it kind of sounds like an on-demand startup.

Ben: Truly, truly. And hilariously part of the business, fast-forward a little bit that they operate now that’s a coffee delivery service, they acquired another company to do that called Tonx when they sort of moved into a bit of a different sector. 

David:  Yup. So the company is back to its origins now with that acquisition later but he does that for a little while and then kind of realize like probably not going to become a really large business if he’s roasting coffee in his own kitchen. 

Ben: No. And it’s hilarious following the parallel to Starbucks. Like both started with this model of beans only and selling those and focusing exactly on that and then realizing, boy, there’s this whole other retail coffee experience to be created. 

David: Yeah, exactly. And Freeman sort of similar to the Starbucks story where it wasn’t the Starbucks founders who realized that there was this retail opportunity. It was Howard Schultz. Freeman himself kind of stumbles into it. So in 2003, he signs a lease for a roastery so he can get it out of his kitchen and start roasting in a commercial space. It’s not until 2005 that he actually opens up his first retail location which is in Hayes Valley in San Francisco and it’s in a friend’s garage. So he has a friend who loves his coffee and his friend has this garage on a little side street in Hayes and says, “Why don’t you come open up a kiosk and actually instead of just selling beans, sell coffee there?” James is excited about this and his sort of approach to coffee, even though the name ‘Blue Bottle’ comes from Blue Bottle Coffee in Vienna which was one of Europe’s first coffee houses, he’s actually more influenced by the sort of Japanese style of coffee. Whereas Howard Schultz was influenced by his time in Italy and the Italian coffeehouses, the whole approach of Blue Bottle is very, very Japanese-centric and the Japanese approach to coffee is very Third Wave. It’s all about the very, very meticulously crafted, perfect cup of coffee. James talks about this in his ETL talk at Stanford that part of his inspiration is this coffeeshop in Japan where the first thing you do, the barista does when you order a cup of coffee is they have a wall with all these cups on it and the barista here, she will go look at the wall and decide which cup (they’re all different) is perfect for you. 

Ben:  Wow! 

David: And so that’s the inspiration for Blue Bottle. And listeners, if you've been to Blue Bottle, if you live in the Bay Area, I’m sure you have or travel there often, this is the anti-Starbucks. It’s very austere. There is very little in the locations except for the coffee. There’s no Wi-Fi. There are no power outlets. They do have some food but very little. It is truly all about the coffee. This idea of the cup James also talks about much later in the company’s history, they had cups specifically made for Blue Bottle. These are ceramic to-stay cups. They don’t like doing to-go cups. The cups are perfectly sized. They’re not perfectly round but they are sized exactly for the sized drink that you get a blue bottle. There are no sizes. You order whatever it is you order and it’s one size. 

Ben: David, I can’t take it. 

David: It's so hipster. The synergies with the tech community are just too perfect. 

Ben: So you pay software engineers more money and more disposable income and they want to be better than everyone else and they want to buy more pretentious things. They love coffee, they need coffee to be productive. I know. 

David: Sell them really expensive coffee that they don’t have to think about because they’re thinking about writing the code. So we do the thinking for them but it’s really good.

Ben: Exactly, exactly. It’s like the Steve Jobs one outfit reduce cognitive load thing. 

David: Exactly, exactly. That is Blue Bottle. Which is very different from Phil’s which we’ll come back to in a minute. Phil’s is the competing Bay Area chain. 

Ben: I should say like Blue Bottle is freaking amazingly good. 

David: The coffee is really good. 

Ben: I’ll rip on it for this whole episode but, you know, it’s an unbelievable product. 

David: It really is. I mean, you can’t be from Seattle and not appreciate good coffee, and it is very good coffee. So after the kiosk, the first very little store in Hayes opens up. It really starts to take off and spreads kind of by word of mouth. They start to open more locations in the Bay Area, then they go to New York City. They go to Los Angeles and then they go to Tokyo, to Japan and the sort of inspiration for all of it. So there’s stores in all of these cities now. But they start to grow fairly rapidly and in 2008. So this is very early in kind of the rise of sort of the modern startup and VC industry. Arguably even maybe I would say before lots of capital, the sort of modern series A and beyond hyped startup, they raise a venture round and they raise $5 million from a firm called Kohlberg Ventures. And Chris Sacca and Lowercase Capital, this is just when Chris is getting going. 

Ben: That dude gets into everything. Un-freaking-believable the nose on Chris Sacca to find those early-stage.

David: Amazing. It was a $4 million fund. So tiny by today’s standards but he was in everything. Blue Bottle, Uber, Twitter and many, many more.

Ben: And then bought up a bunch more of Twitter that he could on the second market.

David: So $5 million round from Kohlberg and Lowercase in 2008. Then a few years later in 2012 they raise a $20 million round led by Index Ventures and Google Ventures and then a whole bunch of other individuals. So Kevin Systrom, a number of other tech CEOs, Tony Hawk the skateboarding legend invests. I mean, this is the thing. We might have talked about this a little bit in the Starbucks episode. You’re literally selling drugs to your customers. 

Ben: Yeah. Oh my God. One of my favorite things to do research for this podcast is to go look at all the quarter responses to reactions around the deal and sort of tease out what I think is a great point and things I want to bring up on the show. And there was one really great quote that I was going to wait to say later but I think it was worth bringing up now. From Daniel James on Quora and this $20 million round, the question was something around like why is Blue Bottle getting all this investment, whether the VCs see it. And he goes, “Coffee is a legal, addictive, unregulated psychoactive drug with cheap ingredients, premium pricing and a huge worldwide growth market. Blue Bottle is a quality brand with a good team and a strong history of well-managed growth To me, this seems much better than a VC bet with many consumer internet companies.”

David: I know. And it’s so funny. I actually think, I remember this round, the 2012 round. Nobody really paid attention to the 2008 one. But the 2012 round was like, you know, it was sort of simpler when we were starting Rover and people are like, “This is a sign of the apocalypse. It’s like Airbnb for dogs. Who’s going to use that?” And it was the same thing there. It’s like, what are these VCs thinking? They’re investing in a coffee company. And to be clear, there was never any even pretense that this was like going to be an internet company. It was like James and Blue Bottle. They’re like, “No, this is a coffee company.” We make coffee, we have stores. People come. They buy the coffee, they drink it. We have a website.

Ben: Reduce cogs and lower variable cost. Like, no, none of that. 

David: No, no. This is a coffee company. And people are like, “Why are these VCs investing in this?” Turns out, they did well and particularly that round did very well. But we’ll come back to all that. 

Ben: It is worth pointing out like the super interesting, near self-fulfilling prophecy of this. The sort of Twitter family and Blue Bottle was joined at the hip very early and they got a lot of sort of -- because they were both at least very early on incredibly product focused companies with sort of super tasteful visionary founders. Like they attracted the same sort of people and they magnified each other. So you look at Sightglass that was a couple of early Blue Bottle folks that left to start their own thing, like they co-founded that with Jack Dorsey. It was an early pilot for using Square at that location. And you see the types of people that were attracted to Blue Bottle as a product and as a lifestyle and put money into it. I mean, it is like they just won over the most valuable segment as customers and then brought them on as investors. 

David: Yeah. We’ve talked about this on this show before but especially if you don’t live in the Bay Area or in Seattle or in LA, you're not kind of in the ecosystem, it’s easy to forget. You read about these companies in the press. They become so valuable. They’re almost like these celebrities. Like, these are real people and these companies exist in real locations. So I don’t know if it was the second but the first sort of canonical Blue Bottle store larger than the kiosk that was in Hayes was in Mint Plaza. And Mint Plaza is like two blocks away from the Twitter Plaza. So where do all the Twitter employees go when they want coffee? They go to the Blue Bottle in Mint Plaza. And it's just like these ecosystems, like everybody’s right there and that’s how these things sort of feed on one another. 

Ben: I thought about this as like a customer acquisition strategy of if you have a company and you want people at another company to buy it for B2B purposes like buy all the Facebook Ads of the employees at that company so that you can get their attention even outside of typical channels. Like, if you aren’t right next to the Twitter building but you're interested in attracting Twitter people, could you target them all over the place digitally as well as having a physical location there because I feel like while Blue Bottle sort of pioneered that, I feel like that’s no longer novel to put something right outside of a company that, anyway, to put a physical location there.

David: Yeah, it's interesting. That growth hacking tactic doesn’t work anymore. 

Ben: Could you be digitally close, yeah. 

David: Yeah, seriously. But it definitely worked for Blue Bottle. And I think Biz Stone was an investor. I don’t know if Evan Williams was. Jack was obviously an investor in Sightglass, a competitor. But it worked. So 2014, they then raise another $25 million and then in 2015, they raise $75 million from Fidelity. And that was like, “wow.” This is like a lot of money from a real public markets investor and then they keep expanding within those cities that I mentioned before. But grow to over 30 stores throughout the country and in Japan and then, a surprise announcement, in the middle of September, on September 14, 2017, it is reported that Nestle comes in and the large conglomerate and buys out a majority stake in the company for a reported $425 million. We don't know the exact number but it’s been pretty widely reported that they paid about $425 million and that was for 68 percent of the company. So they bought out the investors and James and the rest of the management team are keeping their stake. So they keep 32 percent of the company, its own separate board. But all the investors are bought out, so the valuation on the company is $625 million, assuming that the $425 million figure is correct. And here we are.

Ben: Pretty amazing. I mean, I wonder, the first thing that comes to mind is did the founders keep all their shares, was there a little bit of secondary there where they took money off the table. They had have taken something, right?

David: I don't know for sure but they may not have. There had been some secondaries along the way. So I believe some of the money from some of the later rounds was secondary sales that the founders and management team were taking money off the table. So I actually don’t know in this case whether Nestle paid out anything to any of the employees.

Ben: Well, I will say, you know, as I for lots and lots of reasons believe that full acquisitions are better than these sort of majority buyouts, particularly for startups like this, I mean they’re 40-store retail location, but early-ish mid-stage company. But if you're going to do it in this manner where you're not acquiring the entire company, I love the idea of it running independently and the founders still having a ton of skin in the game to make this thing grow in valuation. There’s sort of an interesting thing of like it has to stay a separate company. Think about this. How if you're those founders do you think about how your shares get valued now? Like there’s not really a competitive market to do the next round. Like there’s not a market to value your company. And it’s certainly not anywhere near getting valued on a reasonable sort of price to earnings ratio. So are you hoping that at some point Nestle just decides to buy you out? Is it actually in their best interest to do that? I love the incentive. I’m curious on the mechanics of how that works. 

David:  I think you're hitting on all the right questions here, Ben. I think part of the reason this happened as it did is, I have to wonder. I don't know anybody at Blue Bottle personally, but Freeman and Bryan Meehan who’s the CEO, he came in and took over as CEO a number of years ago. But Freeman is still very, very involved. They both were very vocal about saying they never wanted to go public. They didn’t think being public made sense for Blue Bottle as a company and it also just was something they weren’t interested in. And yet, the company continued to grow but at the same time did raise all this money and in particular, in some of these later rounds, bringing in folks like Fidelity. Fidelity is a mutual fund. They’re a public company investor. They want to return. All the investors want to return but particularly them and they want liquidity. And so I can only imagine the tension that must have been building as they were making these decisions to take these partners on along the way, these partners as investors who just had sort of fundamentally different goals than what it sounds like James and the team did. 

Ben: Yeah. Okay. So here’s the question is, did that dichotomy just continue to grow and grow and grow where they were diametrically opposed to going public, they were taking on investors that needed them to go public or needed to have a big liquidity event and in a reasonable timeframe and like they sort of were rocking a hard place.

David: Yeah. I mean, that is the question. And I think the question both for Blue Bottle and for us in terms of in this show like looking at what’s going on in the tech world, like Blue Bottle, we were joking in the beginning of the show that it is unapologetically not a tech company but this type of dynamic is rampant these days. I mean so many founders of tech companies have raised all this money and yet are adamant that they never want to be public and that a lot of them also say they don’t want to sell the company either. So, like, what are you going to do?

Ben: Yeah. I mean, it seems like that would have been a nice thing to be aware of upon investing. 

David: It does seem that way. It does seem that way. And it’s so funny, it’s also so --

Ben: Is that lip service, David? Like, is it like how if you want to run for president you're supposed to say like “I’m not interested in being president” and then like you reluctantly do it so you don’t seem power hungry. Like, is it like, “Oh, you know, we never want to sell out” and then you inspire your employees and you're mission-driven forever and then until the day that it happens it’s never going to happen? 

David: Yeah. I don't know. I mean, you could say so but then we’ve talked about this in so many episodes whether about Snap or about Facebook. These companies, the majority of them, obviously not Snap and Facebook, but have been private for so long now and they just keep staying so, like you know, Uber and Airbnb, all these companies and many, many others. Certainly could be public companies and probably should be. But the founders are for whatever reason either delaying or even saying they don’t want to. But I think also like there’s a tension here. I mean, on the one hand, I think we’ve been painting it for the last few minutes as bad or at least that this is a disconnect which it is. But on the other hand, if you go back to sort of what Blue Bottle is and this whole Third Wave of coffee which we’re using as an analogy for the state of the tech world right now, does it make sense for Blue Bottle to be a public company? I mean, it makes sense for Starbucks because Starbucks’ goal is to be everywhere and on every corner. But if Blue Bottle’s goal is to be about the cup of coffee and what is actually in the cup, does it make sense to be as big? I don't know. 

Ben: Yeah. I mean, Blue Bottle has 40 locations, right? They have plenty of growth ahead of them if they want to. Starbucks has 24,000 locations. You don’t need to be a public company to be a 40-location coffee shop. I’m actually very curious too. They also have this online business selling directly to consumers I’m super curious what the revenue mix looks like. I would suspect a lot more of it is either buying coffee in the stores in liquid form or buying the beans in the stores and then the online subscription business is smaller. But interesting to think about that too because then you start to think about it, still not an internet company. I’m really sick of the fact that, like, oh, we sell it online and people subscribe to it. That’s a slight business model shift but ultimately at fixed cost, distribution cost, still not an internet business. But then you at least drift closer to something where you're like, “Okay,” this is different than all the brick and mortar stuff that exist today. 

David: We’ve posed some questions here and I think James Freeman and the Blue Bottle team were very clear what side they came down on on those questions which was that Blue Bottle can’t be a public company and maintain its ideals and also that it’s not an internet company. But I do think in terms of where I come down on this, I’m not sure that that’s the dichotomy that makes sense. Like I think about Apple. An Apple store and a Blue Bottle store are eerily similar. And Apple is maintaining --

Ben: What Apple store used to be anyway. Like I think the days of believing that an Apple store is a far simple location is far over. 

David: Well, no. But you walk into an Apple store and you can count on, well, you used to be able to count on both your hands the number of products they were selling there. It's more now but it’s certainly not relative to the number of square feet that they have. The number of products that they’re selling is way smaller. But that has been able to scale and touch just about everyone in the world. Whereas as you pointed out, Blue Bottle has 40 stores. 

Ben: I’m curious to get into acquisition category because I’d love to get your take here. You want to dive into that now?

David: You know, let’s do it. 

Ben: All right. So I’m curious what you think. The thing that I have bolded in my show notes of our categories (people, technology, product, business line, asset, or other) is product because it's really a fantastic product. A lot of care in every cup. Truly differentiated in terms of once you have it, you kind of want to go every day to that. You don’t want to go for anything less. Do I think Nestle could create that? Probably. Like, do I think they could create that for way less than they paid for Blue Bottle? Certainly. Would it be successful? Almost certainly not. Like I think ultimately what they have bought here is the brand and the prestige around the brand. And they’re going to try and leverage that into all sorts of, well, I think they’re going to try and leverage that into all sorts of interesting ways of using their supply chain to really amp up the growth rate of Blue Bottle to potentially sell other stuff in Blue Bottle, to sell Blue Bottle Coffee everywhere they have store space. But they bought brand here. They bought coolness. 

David: Yes. I was going to go with business line because yes, there are all those things that Nestle could do with Blue Bottle. But they’re such a risk if they do, that they do that they destroy the brand, right? And I don’t know Nestle, the full ins and outs of their corporate structure but I don’t think the have anything quite like Blue Bottle which is like a physical retail experience. So this is something kind of new and different for them. But I think you also raise a great point that this is a business line but it's not one with a ton of crossover. There’s crossover potential but there are so many landmines in there. 

Ben: Yeah. I don’t think I really considered that that much. The question is, I mean, if it’s a business line, then it should be freestanding and that means that you should believe that some are future cashflows on this thing are going to be $625 million. That’s a lot of growth. 

David: Yeah, yeah. But on the other hand, so I’ll foreshadow, we’ll get into this more in tech themes. But this really is kind of like, it’s so interesting. Like this is a Facebook style acquisition being done by Nestle. They’re keeping the team’s effort. All the rhetoric is that they’re going to let Blue Bottle just keep doing its thing. It’s a separate board. The employees and James (the founder) still own a significant chunk of the company separate from Nestle. Yeah. But I don't know, what do you think? Is it going to work? 

Ben: I mean, so what are they going to do? The question is like, what are they going to do with it? Are they going to try and put Blue Bottle in more places? Because I believe Nestle can probably do that. Like if that’s the goal and it’s really just to create a ton of the exact same Blue Bottle experience in more places, yeah, they can probably do that. And a big capital infusion is a really good idea to do that. 

David: I mean, Nestle can be a much larger capital provider than even however much money Blue Bottle could raise as an independent company. You know, even an $875 million firm Fidelity, but Nestle could write that in a week. 

Ben: Right, right. So I was reading this interesting Quora post that’s like it gives a good order of magnitude for what individual cafes sell. And I feel like I should have gotten the Starbucks comp because that would have been better. But this is in Australia, 60 percent of cafes sell between 200k and $2 million per year. So let’s say that the revenue side, that’s $2 million of revenue per store that Blue Bottle generates. That’s a lot of stores to get to $625 million. 

David: Well, it’s not just revenue. Back to your point a little while ago, this is not a tech company. Let’s say they have 40 stores doing 2 million of revenue in each.

Ben: High-fixed cost. 

David: Right. Like, okay, they had 80 million in revenue, let’s say. But the margins on that are not software margins. 

Ben: Right, right, right. I did read one interesting piece that I thought was pretty interesting. That said that basically, Nestle had to do something in coffee because they have dominance in Europe with Nespressos. And by the way, having a Nespresso machine, we have one at work, these things are freaking awesome. Seventy percent of the single-serve market in Europe is Nespresso. And they tried to penetrate in the US and completely lost to Keurig and Tassimo and they have less than 5 percent penetration in the US on those single-serves. So the question is, if they came out with a Blue Bottle single-serve thing at home, would they be able to win some of that back. And the reason it’s important is because across Nestle’s businesses, their margins are about 15 percent and in their beverages it’s about 25 percent. So anyway that they can make more of their beverage business lines, they can generate much higher margins and this could be a huge missed opportunity if they have to forfeit the single-serve coffee market in the US as it just skyrockets in popularity. 

David: Yeah. Interesting, interesting. So this is bad. But the right way to do the Juicero…

Ben: Yeah. Actually, David, I tried the other day just squeezing my Nespresso pod and they made amazing coffee on their own. I don’t know what I paid 100 bucks for this thing for. 

David: Yeah. Well, you can’t do that with coffee. 

Ben: No, no. So let’s paint this scenario. If it is a separate business line, like this is a totally new thing that may or may not work which is a leveraging of the brand into something that the brand may not be able to be leveraged into in the sort of single-serve home thing. Like would they pit Nespresso against Blue Bottle and have two divisions making similar things selling against each other? I mean, maybe it would be the same division and they would just sort of re-label the Nespresso stuff. 

David: Well, if Nespresso, and I agree, they really do make good single-serve coffee much better than Keurig’s, but if they have such small market share here, maybe they just re-brand the whole thing in the US as Blue Bottle.

Ben: Yeah, I wonder. And how much of it, say, do the Blue Bottle folks have in that. I mean, presumably Nestle makes the decisions now and has the controlling interest. 

David: Yeah. But again, remember, like they don’t 100 percent. The Blue Bottle team still has a large stake. There’s just a lot of complexity to this deal for so many reasons, as we’ve been talking about. 

Ben: Yeah. I like your assessment of business line. I’m curious. It is that for now. I’m curious to see what sort of integration we start to see. 

David: I feel like we’ve talked a bit about what would have happened otherwise. But I guess if Nestle hadn’t come in and acquired Blue Bottle and nobody else for a while, I mean, what happens? So like Fidelity is sitting there on their cap table at a very large stake and they’re not in the business of owning shares in private companies for 20 years. What happens? 

Ben: Yeah. I mean, presumably another Nestle would have to come along in some amount of time. You can really see the dynamic here play out where the founders are like, “we don’t want to sell,” and they end up keeping all their shares. And the Fidelity’s are like we need to get out of this business. We’ve seen great growth but my God, we need a way to get out of this. You almost wonder did Fidelity tee this whole thing up with Nestle. 

David: Well, and not just Fidelity too. I mean, don’t forget there have been VCs on the cap table here since 2008. So almost 10 years and venture capital funds have a life cycle. This is something that I think a lot of people don’t really understand unless you're an insider in the business. But the typical life of a venture capital fund partnership/limited partnership is 10 years. And what that means is that from the time the fund was raised until whatever that data is in typically 10 years, like you're supposed to wind up the whole fund and give all the money back to investors at that point. Now, in most cases there will be provisions to extend the life of the fund that almost always does happen but still then as the VC, you're having to go back to your investors every year and keep asking for an extension and eventually they’re going to get tired until you know. 

Ben: And then what happens, David, this is a good little VC 101. Like what if the LPs say no and there’s still shares owned of these private companies that haven’t got liquidity yet. 

David: Well, what would happen then is those shares would get distributed out to the investors in the VC fund, the limited partners, and that would be really bad for the company too because now all of a sudden instead of XYZ VC saying -- let’s say Index who led the Series B in Blue Bottle, so instead of Index as your investor and sitting on your board, now, ratably, all the unproportioned, those investors in Index, they all own little bits of your stock now and they’re in totally different businesses like they’re not in the business of sitting on your board, helping you grow. They may have different liquidity timeframes, return hurdles. It just turns into a nightmare. 

Ben: And so then you could have 50,100, 200 new entrants on your cap table.

David: Yup, yup. And not just new entrants but new entrants with wildly divergent interests.

Ben: Right, right. And presumably at some point that starts to trigger some things that need to happen with the SEC because you have so many shareholders. 

David: The rules have changed on that a little bit with the Jobs Act. But still. 

Ben: No Bueno. 

David: Yeah. No Bueno. So I kind of think, we talked about this before, but like, we’re going to see a bunch of this in the coming years. Like if some of these companies don’t get public or acquired, there’s going to have to be some sort of transaction that takes place. And maybe private equity is a path, so that might have been one thing that might have happened otherwise. You saw this with SurveyMonkey. So, similar situation. The company of Dave Goldberg, Sheryl Sandburg’s late husband, was the CEO and he was adamant, never wanted to go public but had raised all this money. And so actually several times the various private equity firms came in and bought out the existing investors in SurveyMonkey. And then even larger private equity firms came and bought out smaller private equity firms. 

Ben: Right. There is a bigger fish for a while. At some point, they run out of big fish in the public markets where you need to go.

David: It can’t be turtles all the way down. There has to be a pool at the bottom. 

Ben: Oh, man. I’m using that as the teaser quote for this episode. 

David: Love it.

Ben: Okay, one other VC 101 moment. So of course every day is a day that goes by where it would be nice to have a return on your capital so that you can invest it elsewhere. But why don’t VCs more typically do an evergreen fund so they don’t have these sort of artificial fund vintage triggers to force this to happen? 

David: Well, some VCs do. So like Sutter Hill is an evergreen fund. The thing about that though is that everybody has to be aligned in the partnership, both the VC partnership and then the limited partners about wanting. So all of the limited partners have to be able to say like, “Yup, we don’t care about timelines and liquidity.” But then even more importantly, the general partners in the VC fund have to also be willing to say like “I don’t care about liquidity either.” Most VCs, some are very wealthy independently or have been VCs for a long time and have gotten liquidity and aren’t as motivated. But really, if you look around the industry, especially in these multigenerational firms where the folks that are running the show or making investments now maybe aren’t necessarily the founders, they’re not in a position where they can just indefinitely go without liquidity either. And especially as a VC and investor in these types of companies, it's not like if the company is making and generating positive cash flow, it's not like they’ll dividend it out to you. So whereas if you are a founder of a company, you can start to pay yourself a lot more. If there is cashflow you can dividend it out or you can do bonuses or whatnot. None of that when it comes back to VCs. 

Ben: Yeah. Great point. Well, thanks for sidetracking there with me.

David: All right. Should we dive into tech themes? 

Ben: Yeah. Let’s do it. Let’s do it. Here’s one that I don’t know if it’s actually applicable but I’ve been thinking more and more about. And I think what I’m going to do here is walk myself into a corner where I say actually this is not a tech theme for this episode. But the return of brick and mortar in a different way than it was used before is really interesting to me where, you know, the story of the decade or the last two decades is Amazon taking 97% of retail growth, Walmart growing a little bit and everyone else shrinking and especially big-box stores shrinking. And this return of kind of boutique retail where even the online companies, Warby Parker, Bonobos, the sort of direct from internet to your doorstep companies are opening stores, and in many cases they’re doing the stores very differently. So like, you go to the Warby Parker store you don’t actually buy glasses there you buy them on the website in the store but you can kind of try it on. It’s almost like a marketing expense, like a brand awareness expense and a way to make the experience a little bit better. Now, as I said, I was walking myself into a corner. This isn’t quite the case with Blue Bottle. But it is sort of a part of this boutiquification of retail away from the man. 

David: To invoke Ben Thompson a little bit, like it is a little bit aggregation theory in that what these new retail experiences do have in common, is they are a superior customer experience versus you are going to Warby Parker for one specific thing, you're going to Blue Bottle for one specific thing. You're going to an Apple Store for a one specific thing. Like there aren’t thousands of skews just lying around on the floor. And so as a result, you can have a much better, purer experience of that thing in that store and as a result, if you're able to get distribution, now this is where it breaks down a little bit in the physical world versus the aggregation theory on the internet. If you're able to have distribution wide enough and you have that superior customer experience, you will win every time. I mean, if there is a Blue Bottle next to a Starbucks like I’m going to the Blue Bottle, you know, but in the physical world and I think this is also, Ben, what you were talking about in the beginning of the episode like Blue Bottle has been valued like it is an internet company but it’s not. Like they need to have a store everywhere to do that and that’s going to require a ton of capital. 

Ben: Yeah, it’s pretty interesting. I mean, the way I like to think about internet companies being differentiated is the super low, if not zero marginal cost. You can have super high fixed cost but low marginal cost especially not businesses like Apple that make hardware but like internet companies. As you sort of look around at those businesses they tend to be winner-take-all. Facebook is a winner-take-all business and Amazon will be a winner-take-all business, and Amazon doesn’t quite fit but maybe Amazon as the third-party seller group kind of fits. So the interesting thing here is like coffee stores are not actually winner-take-all. Like, despite the fact that Starbucks, you know, it's not just the internet that allows you to quickly saturate a global market. It’s many other factors of our world today too. It's our ability to do logistics at mass scale, our ability to do single advertising campaigns at large scale where you quickly make a brand understood by many, many people. So it’s slower than if it were just bits because it’s in the real, real world. But Starbucks, while expanding to a global market fairly quickly, I mean 24,000 stores, it turns out there actually are segments and it’s not a one-size-fits-all for everyone to create the best experience when you're in the real world and maybe even when you're in software too. You can’t create the thing that’s best for everyone under one single company. 

David: Well, you can though if you're a marketplace. Right? And I think that’s why Amazon can be a winner-take-all business in retail because, like, you can buy the, I don't know, what’s some trivial example? Like an iPhone dock. Like, you can buy the $3 iPhone dock from China on there but you can also buy the like $500 artisanal, you know. You can get your Starbucks and your Blue Bottle on Amazon.

Ben: Well, that works on a product perspective but doesn’t work in a physical experience perspective. 

David: Yeah, exactly. 

Ben: Even if I could get exactly Blue Bottle coffee, like if I’m going to a Starbucks to get that, it’s not the same. 

David: Yeah, right. So this is where the analogy breaks down in the physical world. 

Ben: It's kind of interesting. Like if you go back to a traditional version of marketplace. Like before, it was this category of VC investable businesses, it was large square footage areas where multiple merchants were in a single place. And like Blue Bottle doesn’t want to exist in a marketplace either, much like Southwest doesn’t want to invest in a travel aggregator. Like I don’t want to be seen around all that cruft. I want to be in my own little thing and separated from all that. So, I guess the tech theme I’m going with here or the theme I’m going with here is like some things are un-crammable into these business models that are massive and winner-take-all and looks super shiny from an investment perspective, and I think coffee may be one of them. Like Starbucks is killing it, they’re doing great. But like, are they the answer for everyone? No. 

David: I certainly agree with you in coffee as it exists today. But I’m thinking about like Airbnb though. Like a Holiday Inn was very different from a Ritz-Carlton, right? There were segments there for sure. But both of those experiences and both below a Holiday Inn and above a Ritz-Carlton exists on Airbnb. A platform like that actually can address if not the whole market, you know, many, many segments. Part of it is tied to maybe it’s just the nature of the coffee market, but I think it is also tied to this like physical nature of these businesses. Like you can’t do the same with coffee, right, because the experience of sitting in a Starbucks is very different from the experience of sitting in a Blue Bottle. They can’t kind of coexist.

Ben: Could Blue Bottle move down market at some point and open Starbucks competitors and like there’s Blue Bottle classics and then there is Blue Bottle something new?

David: What’s interesting, Starbucks is doing this with the roasteries. They’re moving --

Ben: They’re going to upmarket.

David: Yeah.

Ben: And like, can Starbucks actually win over the coffee snobs? I mean, that’s a tougher battle than like suddenly there being a $4 latte that’s available from Blue Bottle in a larger location that has Wi-Fi. Then I feel like I’m almost one of the cool kids and I have the product that I actually want.

David:  Well, maybe the way they have to do it though is what we were saying earlier which was through the single-serve packaged coffee. 

Ben: Go through the home instead. 

David: Yeah.

Ben: Yeah, interesting. I mean, who knows what direction they’ll go but I’ll put the flag in the ground and say I just don’t think you can do a winner-take-all business and create a product for everyone when you have to think about the physical experience of it too. 

David: I can’t think of an example that is not an internet business that can serve everyone. Like Google can serve everyone and Facebook can serve everyone and Instagram can serve everyone and Airbnb and Uber. 

Ben: Even actually not Instagram and even not Facebook, like there’s so many people that want to select into their social network because Facebook is too public for me or Instagram is too limited. 

David: Yeah. Good point. 

Ben: I’d say we may be nearing… no, I’m not going to go there. Like the pushback of the one-size-fits-all but in some ways. 

David: Well, okay, maybe Amazon can. Like who wouldn’t buy from Amazon? 

Ben: Environmentalists. 

David: Hmm, environmentalists, maybe. Yup. 

Ben: I mean, I’m looking for corner cases in some ways. But do I believe that Amazon will be able to solve the problem of shipping products to environmentalists? Yes. Like that’s a bet I’d make. 

David: Yeah. But I think you're on to something. Like it only works because you don’t have to go physically shop at Amazon. Because before Amazon, there was Walmart. But there were whole segments of people that would never shop at Walmart and likewise there was whatever high-end equivalent of Walmart you want to peak that doesn’t exist anymore. 

Ben: Target?

David: Target. Right. Well, Target is sort of I think more mid-market or maybe slightly upmarket certainly from Walmart but I don’t think it’s the Neiman Marcus of big-box stores. Just about every demographic, unless as you point out, you have an environmental concern, would shop on Amazon, right? 

Ben: Yeah. 

David: Because again, you can get your $4 iPhone dock or your $500 iPhone dock there. 

Ben: Yup. They’re getting there anyway.

David: Yup. All right.

Ben: You want to grade?

David: Let’s do it. 

Ben: All right. You start because I don't know. 

David: Well, this is tough. I mean, it’s kind of like everything worked out here. Investors got a nice return, especially the early investors. The management team and James certainly seems happy. I mean they’re leaving a ton of skin in the game so they must be bullish on the future. Nestle is getting potentially, well, they’re getting a growing brand and new business line to add but they’re also potentially getting something that could really be valuable to them in terms of rebranding their Nespresso single shot market and that’s a very big market. But it just feels like this whole thing wasn’t the right fit, you know, as we’ve had this discussion. I think I’d give it a B right now because this certainly was a good outcome for everyone but I just wonder if it was like the right path and what would have happened if maybe Blue Bottle had made some different decisions along the way. 

Ben: I don’t disagree. It does feel like my biggest takeaway is with the real successful acquisitions we’ve seen, when you really dig in, you start to see like the one real reason this deal got done. And with Instagram it’s like “Oh my God,” Facebook can unlock even more supply, like even more add inventory and push all of their advertisers into a crapton more ad slots. Oh, that’s what that deal is about.

David: And they had an existential threat in losing mobile. It was very clear what it was about. 

Ben: Right. And you know, there’s others. You see exactly what Disney wanted to do with Marvel. There’s their businesses turning super valuable IP into dollars in 11 different forms, and boy, are they firing out all cylinders of all 11 of those, pump them into the Disney machine. And what I can’t see here is like what’s the one reason they did this. Like I think it’s probably a good idea, like it seems like a good thing for Nestle to own. I can paint the story where the rebrand of the Nespresso makes lots of sense. I can paint a story where instead of growing 50% year over year and projected to grow 70% year over year next year, like they actually really turn it on and are able to open lots more stores very rapidly because they have all this capital. But like, do I see the one thing where this fits perfectly in and there’s internal alignment within Nestle of how they’re going to leverage this asset? Like, I don’t work there but probably not. 

David: I think the only dark horse being the Nespresso, I mean that may just be a huge business and they needed a way to invigorate it. 

Ben: Yeah. Thank you to the Quora commenter who suggested that. It's pretty interesting. So I’ll go B-, you know, maybe C+, but again, I’ve rated things that were way worse than the C’s, so I’ll go B+. 

David: Carve out?

Ben: Carve out. So I was on a flight to Ohio this weekend and had lots of free time, I was clearing out my Instapaper. And this really interesting thing, I first heard about it like two years ago, that Tulip Mania story. There was a Dutch tulip bubble where people were going insane for buying tulips and it grew to religious fervor where people were paying unbelievable amounts for certain special types of tulips and highly speculative “I’m going to buy this bulb and it will be beautiful in some number of years from now.” Like total mania, right? The same way that we see bubbles that exist today and it’s kind of like the first macroeconomic bubble that people cite. And theoretically, like, crashed the Dutch economy and there was incredible despair and people lost fortunes and all this stuff. And the interesting thing was over the last few years, I’ve actually seen more and more of the story pop up in more places especially in the technocrats sphere where people loved to wax philosophically about it if we’re in a bubble or not. There’s even a movie coming out, I think it’s Tulip Mania or Tulip Fever or something this month, and the Smithsonian magazine published a really interesting piece called There was Never Really a Tulip Fever. 

David: Oh, I’ve heard about this. 

Ben: It was super interesting. Like this thing that’s gotten quoted and quoted and quoted and like referenced over and over again, like somebody wrote this book and did a bunch of research and tried to figure out like, okay, who were these people that lost their fortunes. And as they dug into it, they realized, like, of course there was over speculation here and the people, a lot of very wealthy people put lots of money in and lost that. But it never actually affected the working class and it never actually destabilized the whole economy and it didn’t throw anything into like a tailspin. It did not have these trickle-down effects that are so often quoted when wanting to compare a potential oncoming bubble or 2008 or 2002 to this Dutch tulip bubble. It’s like a totally fascinating analysis of why we wanted to believe that this mania created even more devastation than it actually did. 

David: Hmm. Interesting. Relevant to today’s times. 

Ben: Yeah, yeah. And there are some cool little takeaways in that and suggestions of why we do want to believe it but I’d say I’ll leave it to the author who’s way more eloquent at explaining that. So, click the link in the show notes if you want to check it out. 

David: Cool. My carve out today is actually random-seeming, but is the iPhone SE classic. So I watched the Apple Keynote a couple of weeks ago. We talked about it a lot on the HTC episode. It was really great. And, you know, coming out of it, so for the last three years I’ve been a Plus model guy. I got the 6+ and then I got the 7+, and coming about it, I wasn’t that compelled by any of the hardware. Like I see where they’re going with the iPhone X. It's the future, it’s amazing but I was like, I’m not ready just yet because AR isn’t like really yet. It will be in the next generation or two. Then I realized, I was like, I was looking at the iPhone X and I was like, “Oh, it is smaller. It would be nice not to have such a big phone in my pocket anymore.” Then I just kept looking at my 7+ and I was like, ‘this thing is enormous.’ And like, I can’t sit down with it. I’m like, for the last three years every time I’ve had lunch or dinner or gone out, like I always put my phone on the table because I can’t have it on my body and so I was like, you know what, there’s such an active liquid secondary market for Apple products. I just sold it on eBay and I got an iPhone SE on eBay for way cheaper and I’m sure I will upgrade in the next generation. But I’m really happy to be back to having a small phone, I never thought I would say that. 

Ben: This just in: Venture capitalist decides not to partake in new high-tech technology and rolls back to the Stone Ages.

David: That’s me. That is me. No, it’s such I’m always like all my whole life I’ve been a bleeding edge adopter but the form factor, I just kind of realized, yeah, maybe I’ll probably change in a couple of years but honestly it’s just nice to be back to being able to have my phone in my pocket. 

Ben: I’m envious. I’m envious. You're so right on that. I think were it not for these cameras and sometimes when I want two-handed use of a larger keyboard, I’ve missed the crap out of that form factor. 

David: Swipe-glide typing though on the G keyboard, the Google keyboard is pretty good. And I think this is it for me. Like I’m not much of a photographer. I don’t take that many pictures whereas I know you do. So I was like the appeal of the cameras for me is AR in the future and I just don’t think it’s there yet. So I’m going to enjoy my 1 or 2 years, probably 1 year with a phone in my pocket. 

Ben: Well, David, enjoy your non-bionic phone. 

David: I know. I’m going to miss the bionic. Are you going for a X?

Ben: If I can get one. I’m going to dual wield and have my browser open and try to order online and have my Apple Store app on my phone open and see if maybe I’ll end up with two, I don't know. But I bet I’m into Q4 or if not in early Q1 next year. 

David: That’s the thing about Apple products, right? Like if you are an iOS person, the secondary market is so liquid. Like yeah, you have to pay some transaction costs but like not that much.

Ben: It's crazy. And they keep their value. Incredible.

David: They keep their value. You can swap out for really not much money in terms of economic impact. It’s kind of crazy. 

Ben: It is. It is. Well, that’s all I’ve got. Do you have anything else?

David: That’s all I got.  

Ben: All right, listeners, if you aren’t subscribed and want to hear more, you can subscribe from your favorite podcast client. If you feel so inclined we would love a review on iTunes. Other than that, join us at Acquired.fm. You can join the Slack and that’s all we’ve got. Have a great day!

David: See you guys soon. [music]