Web 2.0 meets Virtual Worlds

I am a bit post-happy today but I could not help but post this. Check out this link on Hackdiary. It is a mashup between Flickr, the poster child of Web 2.0 and SecondLife, the poster child of virtual worlds. Very cool.

Google, MSN, traffic acquisition continued

SeekingAlpha posted my Saturday blog on Google's traffic acquisition costs (post here). I would encourage you to read the comments as it is an interesting conversation. David Jackson at SeekingAlpha posted a follow up post entitled Microsoft's Search Problems or Googles? that further illuminates the issue (see the comments on this post as well). I think over the coming 6 months this issue will get increasing virtual ink and it will be interesting to see the chess moves that follow up on:

The Ebay-Yahoo Alliance
Google and Dell Partnership
Microsoft's new adcenter
and more

Lots is going on in this space and it bears following.

Speed Dating cum Social Networking

Between 5-10 years ago I learned of a concept called speed dating that had become the "new thing" in the orthodox Jewish dating world. The concept basically was that you put tens of male singles and tens of female singles in a two circles facing each other and one gender rotated around the room so you could meet all the members of the opposite sex in the room and decide if you wanted to pursue a relationship to the next step. You spent around 5 minutes with each person and kept a checklist so you could remember who you wanted to follow up with after the blur of faces. In 5 minutes you were supposed to appraise the chances of getting to the finish line (i.e. marriage) with the candidate. It was kind of blind dating on steroids and at breakneck speed.

If it took 5000+ years from the first courtship of Adam and Eve through chivalry and other forms of romantic courtship to arrive at speed dating then I guess this is proof that internet time is 500X as fast as time in the real world. Online dating started around ten years ago, morphed to social networking and now we have speed (4 days) blind dating or friending on the internet. Michael Arrington at techcrunch reviews a site called fo.rtuito.us (like del.icio.us URL).

When you register at Fo.rtuito.us it randomly introduces you to another member. You have four days to interact with that member via anonymous email to see if you can become friends. If after those four days both people decide they would like to stay friends, they are added to your permanent friends list. You are then introduced to another person.

I am not sure what to make of this but speed dating has been a pretty reasonable success with numerous couples coming out of it.

Traf Acq Bites Back?

When I was on the board of Shopping.com, we used to break out our traffic sources into three types:

1. Organic (People who typed in www.shopping.com),
2. Algorithmic ( Free traffic from search engines based on your page rank)
3. Purchased traffic (Traffic from bidding on key words on Google and Overture)

Wall Street analysts have picked up on this trend and break out the gross margins along these lines. Purchased traffic is referred to by analysts as TAC, Traffic Acquisition Costs, and are watched religiously as a sign of gross margin expansion or erosion. As competitors get better at keyword purchasing and management, the cost of acquiring the traffic goes up (and along with it Google's profitability) and the margins of the likes of shopping.com go or other online retailers go down. This puts a premium on being first in line for the users so you can get organic traffic. The site at the top of the pyramid, the user gateway, wins big. The top of the pyramid in this game for the last 4+ years has been Google.

I am beginning to wonder if the tide is turning. I have written in the past on why access matters. DSL providers like SBC are at the top of the user pyramid and control a lot of the default settings that users see. Yahoo pays SBC handsomely for that deal. Google now has at least 3 deals in which they are paying handsomely for traffic acquisition: AOL, Dell and Firefox. Google paid $1Bn for 5% of AOL and a revenue share % that is not disclosed but was reported to bring $400MM to Google on an annual basis.

Google is rumored to have signed a deal with Dell to pay $1 Billion over 3 years to install Google software on Dell PCs and operate a Dell home page with Google search. The blogosphere was ripe with speculation as to what software would be installed. I think that misses the point. This is really a way to bring more searchers into the Google net who will click on ads ultimately. This is essentially TAC.

Finally, Google pays some large amount of money annually to the Mozilla foundation to be the default search engine in the search box on the firefox browser. This is a great demographic. And this is also TAC for Google.

What do Dell, AOL and Firefox have in common, they are all gateways to users. They are gateways that stand in line in front of Google.com. Google is paying to bring in traffic in the same way that many companies pay Google for placement. This is particulalry topical in light of Myspace's emergence as a gatekeeper and rumors that they will soon do a deal with Yahoo, Google or MSN.

So why did I put a question mark in the title of this post. There is potentially one big difference between the TAC that Google pays and the TAC paid by online retail sites and others bidding up keywords on Google. Note that it seems that all of Google's TAC deals are flat fees (maybe with the exception of Firefox) whereas companies that advertise on Google are paying ever-escalating fees. Google is betting that the keyword bidding process used to place ads on its own site will outpace the cost it is paying to acquire traffic from the gateways are access providers and that the traffic to Google.com or whatever it will get through its own access initiatives (WIFI) will drive ever higher margins because of the traffic advantage. Investors might want to pay attention to the rise in average CPC bid on Google relative to the flat fees Google is now paying out to acquire traffic. And maybe, Traf acq might bite Google back?

Only in Las Vegas

After my last experience at the Riviera hotel in Las Vegas (you can read about that here), I upgraded for this trip and stayed at the Bellagio. Vegas is, to say the least, a unique place. It seems to attract all types. From hypodermic needle users that I was warned about on my last trip to the Riviera hotel to yarmulke-wearing cab drivers. Yup, as I left the Bellagio late yesterday morning and made my way to the front of the long taxi line, the cabbie that pulled up for me was sporting a black velvet Yarmulke (kippa). What are the odds?

I was, of course, wearing my yarmulke and was counting how many seconds it would take for him to start playing Jewish geography and share his life story. Exactly 20 seconds. So he grew up in East Flatbush, worked in Fairway on the West Side of Manhattan as a teenager (I grew up not far from there) and somehow developed a gambling habit and began shuttling from New York to las Vegas. To spare you the details (the ride to the airport is 15 minutes so I got a lot of detail), he moved to Las Vegas to kick his gambling habit! (must be some kind of immersion therapy) and seems to have found God in Las Vegas through Lubavitch/Chabad. Hailing from Brooklyn, he of course wanted to know/yenta my entire life story as well.

Vegas attracts a lot of intersting types, from people who think they are really getting married on the bridges above the famed Venice canals at the Venetian hotel to those who think that there is also a Liberty Bell in Italy since there is a liberty bell replica at the italian-themed Bellagio Hotel. There are many Asians decked head to toe in Wynn paraphenalia, sporting players cards for the upscale Wynn hotel and snack munching, pot-bellied, middle-aged Americans snapping tons of pictures of the architectural monstrosities they call hotels in Las Vegas (you can't make this stuff up).

But what are the odds that on my last trip to Vegas I would get an Israeli turned Vegas escapist cabbie recovering from 2 divorces and, this time, a kippa-sporting recovering gambler who found God in Vegas? What are the odds (both of my riding with them both and of finding God in Vegas)??? Since I don't play the tables, I am assuming that my Jewish/Israeli encounters in Vegas are my own form of Las Vegas' famed lady luck. At least this kind of luck doesn't cost more than the taxi fare to the airport. Shabbat Shalom

Wall Street meets Woodstock

I am at the Goldman Sachs internet conference in Las Vegas. To finish the day, Goldman Sachs internet analyst Anthony Noto interviewed Jim Buckmaster, CEO of Craig's List. For those of you unfamiliar with Craig's List, it is a local classified-like listing service for anything from apartments to jobs to dating and lost pets. Craig's List is an amazing business, employing around 20 people and clearly making lots of money (no numbers reported). The site's founder Craig Newmark is renowned for his social values and his eschewing -- shall we call them -- capitalist motives.

In that spirit, Buckmaster dead-panned some pearls in his comments today, which I found quite entertaining but left most of the Wall Street types in the audience scratching their heads. It was a fabulous wrap up to the day. Without any further ado, here are the pearls:

1. "We don't sit around the office thinking how to push revenue higher.". - Jim Buckmaster, CEO Craig's list in response to a question about what other ways they would monetize Craig's List.

2. Maybe if the Stock Market took a more holistic approach and started valuing companies on social responsibility and social metrics then we could think about accessing the public markets. Having investors crawl over our financials is not for us." - Buckmaster answering Noto's question on whether they would go public

3 "Renting apartments in New York seems to be something of a blood sport." - Buckmaster explaining why they would charge for brokered listings in NYC.

4. "I signed up for an adwords account and did some ads but I guess I wasn't relevant enough so my account only got to 38 cents. That was all the marketing and advertising we did."

Look out Steven Wright. Buckmaster is on your tail.

Investing in Funtactix, an Israeli Online Multi-player Game Studio

We at Benchmark announced late last week an investment in Funtactix, an online multi-player games studio located in Israel. We co-invested with JVP in the deal. While the company is still early, I think there are a number of interesting points I would like to highlight.

I spent years saying that it was too hard to make money investing in Israeli games companies. So what changed?

1. First, the cost of distribution has come down dramatically due to the internet. Distribution used to be a major inhibitor for games companies in general and for Israeli companies specifically. I am hoping we can leverage online distribution to drive that cost down.
2. Funtactix has a breakthrough in technology that will reduce the cost of game development dramatically. Spending $5-10 million to develop a game in a hits-driven business never really worked in the VC model. By reducing that cost dramatically, Funtactix gives us a few squeezes of the proverbial lemon to get a hit.
3. Online games are less driven by hits than their CD predecessors. With online subscriptions and asset purchasing and trading, you can cover the cost of game production (especially if it is lower than normal – see point # 2) with a relatively low user base. It will not produce VC returns unless you get a very large user base (50% less than WorldOfWarcraft will do just fine) but, again, you can get another chance to get a big hit if you can consistently cover your cost nut.
4. Benchmark has been a real leader in the online games space and I think we have figured out what it takes to win (see my partner Bill Gurley's two great Above The Crowd pieces on investing in MMOGs here and here). SecondLife, Habbo Hotel, Codemasters (all Benchmark investments) and others not yet announced, are real leaders of this online multiplayer games space. We think it gives us unique insight as a firm into how to make these companies grow.

I am very excited about this investment and the chance to create great content businesses in Israel. I think this is key to the next paradigm shift we will experience here and I feel privileged to be a part of it. As I have written before, we need the internet and content businesses in Israel. This needs to be a national economic priority. Content and internet businesses are to Israel in 2006 what Intel and IBM were to Israel 20 years ago. As the technology commoditizes, the applications, especially media ones, will help drive returns and jobs.

Web 2.0 Features Might Lead to Scarce Development Resources

I have seen endless companies pitching what I refer to as web 2.0 features. My friend Josh Koppelman has branded the phenomenon "53,651" in a great post on his blog. These nichy web sites may create lifestyle businesses or small community hangouts but are not suitable for venture capital investments. Here is an excerpt from the post (I recommend reading the entire post):

"As more and more entrepreneurs start building what Fred Wilson referred to as second derivative companies, I think they run a big risk of designing a product/service that is targeted at too small of an audience. Too many companies are targeting an audience of 53,651. That's how many people subscribe to Michael Arrington'’s TechCrunch blog feed. I'm a big fan of Techcrunch – and read it every day. However, the Techcrunch audience is NOT a mainstream America audience. "

In a country like Israel, where great development talent is a scarce resource, it is important that the entire industry focus on this issue. Already, it is hard to recruit talent in the Israeli internet industry. The universities are not turning out web-ready programmers and Israel is web-challenged given the histroical focus on enterprise apps, telco infrastructure and chips. This is further exacerbated by the Google talent vacuum cleaner entering the market and snapping up engineers at an alarming pace and a potentially high price tag.

By launching and creating many web 2.0 feature companies, entrepreneurs may unwittingly further dry the well of R&D talent needed by venture backed internet companies. Now, this may not be a concern of the entrepreneurs creating these lifestyle businesses. It may even make them smirk. However, as an industry (VC and tech) and a country we need to create world-beating companies that compete and win globally and this requires a lot of development talent. What are your thoughts.

Looks like TASE investors read my blog post on Buffet :)

I wrote a couple of weeks back about the irrational response to Warren Buffet's purchase of Israeli company Iscar. In the wake of the deal, the Tel Aviv Stock Exchange (TASE) rose dramatically for a couple of days. Well, based on the graph below, it looks like there are lots of investors who agree with me that the Oracle from Omaha is not Messiah. Look at the Volume plowing into the TASE Short in the graph below.

Forgetful husbands #2

And....What if I told you that the one that forgot the luggage was the wife. Now what would you say?

Forgetful husbands

Finally, you take your first vacation with your wife (and without the kids) in 6 years. Your wife asks you to do very little for the vacation. She has but one request. Since you are arriving at the airport from different places, she asks would you please bring her wheelie (carry on luggage) and calls to remind you to bring it just in case you are in typical forgetful-husband mode. You both arrive at the airport 90 minutes before the flight. When you first see each other, she notices that you do not have her bag. She says "where is my bag? That is all my stuff for the trip. We are only going carry-on" at which point you gulp and say "oops I forgot it." There is barely time to call a cab and have it brought to the airport. What would your wife say to you? If you are a wife reading the blog, what would you say to your forgetful husband?

This Blog's Lingua Franca

I have gotten a few requests in the last month to post the blog in Hebrew. Unfortunately, I type like a turtle in Hebrew. Is there a hardy soul out there who would like to translate my blog posts to Hebrew? We could then post also to Israblog and link to scoop.co.il.

Obtuse Government Take #2

I have written in the past about what is wrong with the Education System in Israel and how it needs more privatization. Now I see that the Ministry of Education is putting its full force to crack down on the 80% of schools where parents pay more money than the ministry of Education has deemed appropriate. News flash: parents would not need to pay this money if the Ministry of Education would do its job and educate our children. Because the education is so poor in Israel, parents need to supplement it. Maybe the 80% of parents know something the Ministry does not know. Boker Tov! (good morning!)

The Ministry has this all wrong. They should actually encourage enrichment so kids get educated while the government gets its act together. However, they should insist that the ability to pay is not a condition for acceptance to a school. At our kids school, we have a higher set a payments but we give scholarships liberally. The wealthier parents pay higher rates so that less-well-off families need not pay to get a higher quality education. This is the way it should be. People should feel they need to pay for education so they value it but, as in any great society, we should anonymously foot the bill for diversity and supplemental education for those who cannot afford it. It turns out parents do this much more effectively than the Ministry of Education.

Obtuse Government Take #1

I got on the plane after being away for 4 days and picked up Maariv, one of Israel's dailies. Yesterday was a harrowing day in Israel with 8 people killed in car accidents (here is a list of Ministry of Transportation stats). The newspaper lists the steps the government will take to reduce car accidents (which by the way is the umpteenth government plan). Here are the 5 steps the government proposes according to Maariv:

1. Set up yet another government agency to coordinate road safety programs

2. More enforcement of laws (boy, is that novel)

3. More police and electronic surveillance on the roads

4. A center for research on car accidents (what are we idiots? We need a think tank on car accidents?)

5. Expanding roads and railroads (this one has some merit particularly railroads)

I will save the obtuse people in Government the trouble and cost to the taxpayer of all of this. Here are my suggestions based on years of anecdotal evidence and reading the articles.

A disproportionate number of car accidents involve commercial vehicles, young drivers and what I call accordion cars. So here is the remedy:

1. Raise the age for drivers licenses to 21. This will keep younger drivers off the roads, especially when they are exhausted, having come back from the army for the weekend. It may not be popular but saving lives is more important.

2. Ban commercial vehicles from the road during high traffic hours (2 of the accidents yesterday involved commercial vehicles). Let them drive at night and keep them off the highways. These drivers are terrorists on the road. In many places in the US, they have rules like this in effect.

3. Lower taxes on cars. I know this sounds counter intuitive but it seems to me that a large number of the deadly accidents involve smaller cheaper cars with less safety features. The high taxes force people to purchase cars that are less safe because the safer cars are too expensive.

4. Develop the railroad system. This should be the country's highest infrastructure priority and the government's not moving fast enough. We need high speed trains, not the turtle that currently carries people from Jerusalem to Tel Aviv. Also, add more trains in the north and south.

Finally, we need to realize that the beast is within us. The impatient Israeli, always afraid of being a freier (sucker) when passed on the road or out raced on the highways is always tailgating, brighting and being too aggressive on the road. We need cultural reform. We need to stop shouting and stop instilling in children that they should not be a freier. Being a freier is OK, especially if it leaves you alive. In our family, we encourage our children to be freiers (let others have first even at our expense) all the time. It is a good lesson and quite a badge of strength and courage.

And, we don't need any inane government institute, research center or agency to tell us this.

Om on Web 2.0 - Myth?

Om Malik over at GigaOm penned a great piece on web 2.0 ( I know it sound self-serving since he quoted me but it really is a great piece.) You can see my comment at the end of the blog for more thoughts on the topic. One thing I will add here, is there are a lot of VCs in Israel chasing very few quality web deals. That is not gonna end well. See also this piece on SeekingAlpha on the value dissonance between traditional newspaper businesses and their web properties (I commented there as well).

Oracle or Messiah

As has now been widely reported and analyzed ad nauseum in the Israeli press (here in Herbrew in Globes) (here in English in Haaretz) , Warren Buffet, The Oracle from Omaha, as he is widely known, purchased Israeli company Iscar (Owned by the Wertheimer family) over the weekend.

Since the deal, new Prime Minister Ehud Olmert and new Finance Minister Avraham Hirschson took time out of their first day in office to bask in the glory of the deal and claim that Buffet has blessed the Israeli economy, upgraded Israel to the major league of western economies. (Hirschson wryly added on Israel radio that some people are lucky on their first day on the job). The Israeli stock market went nuts, rising almost 2% Sunday on the news of the Buffet deal. The Marker, one of Israel's financial papers and web sites reported that Buffet was eagerly looking for more Israeli companies. Things have gotten so out of hand that there are now even mentions in the press of Buffet buying Teva, Israel's flagship company.

The $4 billion deal was a landmark deal for Israel in many respects including: deal size, Buffet's mythological notoriety and company picking ability and the Wertheimer family's local fame and reputation. While I firmly believe that this is an important deal for Israel, I think the messianic fervor surrounding this deal is entirely out of proportion and may leave some Tel Aviv Stock Exchange investors holding the bag.

Iscar is a one-of-a-kind company in this country. Firstly, it is a family owned business (which is one of the reasons it sold out before the 3rd generation came along) and a private one at that. Iscar reportedly boasts very high net margins (in the region of 25%) or its semi high tech manufacturing business. It is an amazingly automated business (I was blown away when I went to visit it at the level of robotic activity there) that I believe is unmatched in this region. Lastly, it is a business that reportedly did around $500,000,000 in business per year.

There are not many businesses in Israel that meet even half of these criteria and I am not aware of any of them on the Tel Aviv Stock Exchange. Iscar is an amazing business run by a visionary family that attracted Buffet as much for its management skills as for its existing business. While I hope Israel aspires and attains such a level across the industry we are still a distance away from that kind of across-the-board management skills. The Oracle is no messiah for Israeli business or the Tel Aviv Stock Exchange. What he indicates is that if we continue to build great businesses in Israel there will be more potential buyers or exit routes for our companies. And, on that front, I think the press has missed the two most important points of the acquisition.

1. The Wertheheimers mentioned that they talked to hedge funds and LBO funds before deciding on Buffet. This is significant. There is now interest from Hedge funds and LBO funds in Israeli private equity. This presents another exit opportunity for private non-technology and tech companies alike. The big winner on this front is the Markstone Group, the largest Private Equity firm in Israel.

2. The second most significant issue found in an interview with the Israeli Tax Commissioner Jackie Matza is that one of the attractions for Buffet was the 10 year tax holiday he can receive as a foreign investor. This is significant for public market investors and for tech companies as well. Here is why: Israel has given tax breaks to tech companies and other companies for years. However, Wall Street has always discounted earnings from Israeli companies and applied a tax rate to them because the assumption was that the tax breaks were insufficiently long term. If Buffet does anything, giving the Good Housekeeping Seal of Stock Market approval to the tax break will be significant to the company valuations Wall Street gives Israeli companies. Netting out the applied tax rate could give valuations a 10%-20% boost.

No wonder the tax rates in Israel are so high

I wrote a piece in Hebrew for Citizen Journalism Site Scoop.co.il on the impact large governments have on the maximum tax rates we pay as citizens. You can see the article here. But, since a picture is worth a thousand words, here are the graphs that are the result of the research I did, clearly showing a link between bloated governments and high taxes.

Web 2.0 content Takes on Web 1.0 Incumbents

I have frequently blogged on Web 2.0 business models and the distributed nature of content creation in web 2.0. Interestingly, two gorillas of Web 1.0 have rolled out semi-web 2.0 offerings targeting web 1.0 incumbents. Got that?

Yahoo launched its yahoo tech offering this week, putting Cnet (web 1.0 incumbent) square in its crosshairs. The Yahoo model is a web 1.0/2.0 cross with paid writers, editors and user generated content. Over the last year, Cnet has made timid steps to embrace some web 2.0 themes by incorporating blogs and other user personalization features and certainly has mindshare leadership. That being said, wall Street certainly perceives Yahoo as a real threat to Cnet, taking about 20% off of Cnet's stock price in the last week.

While Yahoo certainly has a large user base, Cnet's audience is the tech-savvy crowd and I think it will take Yahoo time to attract that following. Advertisers are after the tech savvy crowd because they convert at a much higher rate than general web surfers (see Om Malik's post here). This was also PriceGrabber's strategy when they competed with one of my portfolio companies Shopping.com. PriceGrabber targeted the tech crowd which had better conversion rates and led to higher profits at Pricegrabber. Long term, yahoo will get this right and get after the demographic but I think it will take some time. This may have a negative long term effect on CNET's stock price.

The second web 1.0 incumbent is much-maligned AOL. Jason Calcannis' impact is being felt with the launch of bloggingstocks.com this week. Jason is clearly after The Motley Fool and TheStreet.com (TSCM) [ whose stock has had a big run in the last 6 months], the web 1.0 finance incumbents, . Both of these businesses have been struggling with their subscription business models any way and AOL clearly senses an opportunity to corner them by offering free content on stocks. I trust this is just an opening act for AOL because the bloggingstocks site is very thin, covering only 8 stocks and with scant analysis (paul kedorsky's take here). The other interesting element is that Calcannis is employing what is basically a newspaper model, having 1 or 2 analysts covering each stock on the blog. It does not appear that he is leveraging user generated content in true web 2.0 form. This is consistent with Calcannis' approach in his own weblogs company which each have a distinct writer and voice for each blog. If that is truly the future, it is simply a blog format re-run of TSCM and FOOL.com but without the subscription model.

AOL is also not known for its finance savvy audience and it will take time for advertisers to feel comfortable with AOLs demographic converting into brokerage accounts and the like. Saying I have a bigger audience than you do as Jason said, is not compelling.

What I find most ironic is that the web 1.0 incumbents (YHOO and AOL) launch web portal 1.0/2.0 assaults on the web 1.0 vertical incumbents (TSCM, FOOL, CNET) without going to full 2.0 extreme. Even more strange though is the categories. Yahoo which has a strong Yahoo finance following decided to get after their weak link first (tech) and AOL which has a big teen and mom-at-home following got after finance first. This web 2.0 world really is topsy turvy.

Patriotic Apathy

I know the title sounds like an oxymoron so let me tell you what I mean. Israel was always a very patriotic country especially at this time of year with remembrance Day and Independence Day. However, something insidious has taken grip here over the last year. I do not know if it was the disengagement from Gaza, The ho-hum election and lack of exciting candidates once Sharon exited, or the disaffected youth. Whatever it is, you can see it with your own eyes, even on the roads.

As recently as last year, at this time of year and in honor of Independence Day, most cars on the road were adorned with Israeli flags on both sides of car. Today, my taxi driver pointed out, 90% of the cars do not have flags at all. You can see it also in the protest vote that brought 7 pensioners into the Knesset in a party without a platform. Disaffected youth brought them into the halls of power. You can see it in the religious community with calls not to celebrate independence Day due to the withdrawal. There are many more examples.

Regardless of the root cause, what is clear is that Israeli citizens of all origins, orientations, ages, shapes and sizes are mentally disengaging from the country and its leadership. This is very worrisome and dangerous. As a small country, we need a vibrant, active and involved citizenship to make many projects work and help the country grow.