Boston Consumer Tech Scene

 To say that consumer tech startups are hot right now would be more than an understatement. Between Facebook, Zynga, Groupon, Twitter, and LinkedIn, the most talked about and valuable startups are all consumer web businesses from San Francisco (Exception: Groupon is from Chicago). Additionally, the most noteworthy financings / launches, including the $41 million Series A round raised by Color and the $50 million Series B raised by Flipboard to name a few, are also consumer web companies from the west coast. Meanwhile, for the past 18 months, New York has been buzzing with dozens of consumer-facing startups like FourSquare, Etsy, Huffington Post (now part of AOL), and Rent The Runway. Amidst all of this activity, many people have begun to question whether Boston is a viable location for this new wave of businesses. So I caught up Alex Taussig of Highland Capital Partners, investors in exciting Boston-based consumer startups SCVNGR and Gemvara, to figure out where the Boston consumer tech scene is heading.

AP: What are your general thoughts on the Boston consumer tech scene?

AT: The legacy of Boston technology is enterprise. When people think about big tech companies from the area, enterprises businesses like EMC and Akamai always come to mind. It is only really recently that Boston has responded to developments in Silicon Valley and started generating energy around consumer technology. Yet, by the time we started funding companies like SCVNGR, Gemvara, and Perk Street, companies all founded by entrepreneurs under the age of 30, we had really started to feel this new wave coming. So the consumer tech scene in Boston is getting stronger. That being said, what we really need to more fully catalyze this is one really, really massive successful standalone company that will spin off other companies. Once the first big company goes public and employees leave to do their own thing, the consumer tech ecosystem will flourish. We are in the very early days of this movement, but I think it is certainly heading in the right direction.

AP: Considering that there are some very interesting consumer startups in Boston, why do you think local companies do not get nearly as much press and publicity as similar startups in New York and Silicon Valley?

AT: Simply because there are fewer of them. You can throw a stone out your window and hit a consumer Internet company in the Valley. And with the geographic density in New York, you can literally walk down the street in Union Square and bump into entrepreneurs you know. It is this critical density of startups in both SF and New York that generates the buzz. Everything is consolidating around Kendall Square now, but if you think back a few years ago, everything was so spread out in Boston that it was very difficult to get that critical mass together to catalyze the buzz. There are several good consumer tech startups in Boston, but there needs to be many more before we reach that critical mass. I know everyone is anxious to get the ball rolling, but the consolidation takes time. This is a virtuous cycle that needs to get kicked off by businesses with real revenues and profits, businesses that go public and make people truly rich. We need entrepreneurs to make boatloads of money that they will then reinvest in the community. Fred Wilson wrote a post about recycling capital and people, which is precisely what needs to happen in Boston. People merely talking about what they are doing at their pre-revenue companies is not enough.  But once we get the real cycle going, the buzz the excitement will follow. The press does not lead the companies. The companies always lead the press.

AP: Some people in the tech scene here in Boston argue that one big problem is the lack of the robust media community and blogosphere necessary to promote all of the consumer web businesses here in town. What is your take on this view?

AT: I spend a great deal of my time on the Internet reading blogs and tweeting as part of my job, and I believe that things happening in Boston are covered fairly well. The problem is not that we don’t publicize the companies enough, but rather that there aren’t enough companies with real revenues doing really compelling things. And I really believe that once Boston-based companies reach that level of success, which they will, the virtuous cycle will take off. We are going through some growing pains right now, where the development of the ecosystem feels incredibly difficult. As cliché as this is going to sound, people really just need to hang in there. We are going to succeed even though it might time some time.

AP: It is clear that you believe in the future of Boston consumer tech, but doesn’t it worry you that many of the best consumer tech companies that started in Boston like Facebook have moved to the west coast?

AT: There is a trend of west coast companies buying east coast companies, even on the enterprise side. But I think many of the interesting consumer web companies in Boston, such as Gemvara, SCVNGR, Perk Street, and CampusLive are bucking the trend you just described. Svpply recently moved from Somerville to New York, but I don’t fault an entrepreneur for making a thoughtful decision about the best place to grow his business. If you want to grow a business that requires you to be close to media companies, it might make more sense to be in New York. However, there are compelling reasons to be in Boston as well. Some sectors, like e-commerce, don’t have any geographic center. If you are building a social networking company, you should probably be in the valley. If you are building an ad-tech business, you should probably be in New York. Yet, in terms of getting the best people for your business, there is something to be said for being a big fish in a small pond. If you are SCVNGR, you have preference on a lot of really great engineering and sales talent coming out of the Boston schools. Overall, it depends on the entrepreneur’s best judgment, and we are happy to support our entrepreneurs in any of these cities.

AP: Speaking of New York, do you think there is any connection between the consumer tech movement down there and Boston VC firms either opening offices or spending extended amounts of time in NYC? If so, is it a problem for Boston?

AT: I don’t think it’s an issue for the Boston scene. I look at it as entirely additive. We have 6-8 portfolio companies down there, most of which are consumer facing. It is an unbelievable explosion of an ecosystem, and as venture capitalists, we have to go where the people starting great companies are going. We may be spending two days a week in New York now, so on the margin, we are spending more time in New York because many entrepreneurs are migrating to New York and our mission is to do what’s best for the entrepreneur. That being said, we still spend lots of time fostering the Boston community, so I do not view the growth of New York as a detractor for Boston. We want both systems to flourish and believe they will.

AP: There are a lot of consumer tech stories in the news because it is sexy and lots of people understand it intuitively. Meanwhile, the enterprise and healthcare ecosystems are both alive and well in Boston. With that in mind, does the lack of a great consumer tech scene matter at all for Boston?

AT: I do think that if there is not a nice balance between enterprise and consumer in a community, it will hurt the community in the long run. Massachusetts’ strength is always going to be hardcore technology because that is something we do better than any region in the world, and it will be that way until other countries surpass us. But having a stronger consumer presence will raise more public awareness for the region and help Boston attract even more top-notch talent. For instance, having Google put Mountain View on the map. At the same time, entrepreneurial ecosystems built around hardcore technologies almost by definition cannot gain traction in the public eye because the public does not understand that stuff. They don’t know what data deduplication is. Even a robotics company is a little too hard to explain to the public. Thus, as Boston begins to develop a stronger consumer tech scene, this will help draw more great people to the region. I do not mean to knock enterprise or hardcore technology businesses, but having a balance between these companies and the sexy consumer companies is valuable.

AP: All in all, what is your 3-5 year prediction for how the consumer tech scene is going to grow in Boston?

AT: We have so many of these companies in our portfolio that if I made a prediction I might basically be telling you what the plans are for these companies, so I am not going to make a firm prediction. But what I will say is that we have the seeds of a very interesting consumer tech sector here in Boston. This sector happens to be interestingly adjacent to other things we are good at here. For example, SCVNGR is a mobile gaming company, which means that while it definitely is a consumer Internet company, it also rides on some of cool mobile infrastructure and gaming technologies, both of which are essentially built into the DNA of the Boston tech ecosystem.

These sorts of companies that are consumer facing but leverage some of Boston’s unique tech competencies will come to make the Boston consumer tech scheme vibrant and exciting. But it is going to take a couple of years before we get companies that are very successful. There is much misappropriation of the phrase “so and so is killing it” or “so and so is crushing it” or “so and so is just an animal.” Let’s see some businesses get built first. Let’s not over-hype ourselves. It is so interesting that we have this simultaneous excitement and insecurity. I spend all my time meeting with startups, and very few startups are actually “killing it.” And when they are, it is very obvious. So if you are an entrepreneur and you got payroll done this week, that does not count as “killing it.” Killing it is when you beat the income projections for the quarter by 30%.  So rather than get caught up in the hype, Boston just needs to hit the ball down the fairway and keep building businesses of value and consequence. That is the only way for the consumer tech scene to grow and flourish.

This dialogue was originally published on Bostinnovation

To Blog Or Not To Blog: VC Insights From Fred Destin

In recent years, blogging has become an incredibly central part of the startup landscape. Founders, startup employees, and tech enthusiasts all comment on everything from new developments at their startups to their favorite bands. Many VCs have become avid bloggers as well. A select few VCs, such as Fred Wilson of USV and Mark Suster of GRP, have built massive followings and rich personal brands through their regular blog posts. Indeed, individual posts from popular VC bloggers like Wilson and Suster can often generate well over 100 user comments. This phenomenon has led more than a few people in the VC ecosystem to believe that having a popular blog is an important part of being a good VC. However, there are many other VCs who do not blog at all and seem to be doing just fine. With powerful evidence both for and against VC blogging, I sat down with Fred Destin, popular blogger and Partner at Atlas Venture, to get the inside scoop.

AP: Why did you start blogging?

FD: I started blogging for two main reasons. First, I wanted to help entrepreneurs get inside the game and understand what happens inside VC partnerships. And secondly, because I invest in consumer facing innovation, I thought investing in it without eating the dog food is a little difficult.

 AP: How has your motivation for blogging evolved?

FD: Today, I blog primarily because I like to write. I derive a genuine pleasure from putting together my articles, it is like my personal creative space. Personal branding is also important. Though I did not start blogging with personal brand in mind, when you are 18 months into it, you begin to realize that blogging can bring very high personal branding benefits. I have walked into rooms at events for startups where 80% of the people already have a personal connection to me when they meet me. This not only helps with meeting people, but it also saves me time because people already know what I think about a wide range of issues. Bizarrely, blogging has also helped me build relationships with the press. Whether it is the Financial Times or the whole crew at TechCrunch, these are people you get to know in a different way because you are co-contributors in the eco-system. So I do think there is a lot of value in blogging that extends far beyond my initial reasons for doing it.

                          

AP: What is your general view on the value of VC blogging?

FD: I do think a lot of the content is undifferentiated, unexciting, and is created because VCs feel forced to use it to push their personal brands. But the best bloggers are very genuine about it and try to be personal and differentiated. Overall, it is wonderful to build mindshare and push your personal brand outside of its normal boundaries through the blog. Nevertheless, I am still only Little Fred from Boston. There is, of course, Big Fred [Wilson] from New York, so it is still tough for me to compete on my first name only.

AP: What have been the biggest advantages and disadvantages to developing a personal brand through your blog?

FD: If you are a Boston-area venture capitalist, and you used to be known for how well you covered Cambridge, downtown, and a bit of Newton, your world just exploded because globalization has finally hit the venture market. There is almost perfect transparency on the venture side, so you can’t just sit back and wait for people to come through your office. You have to be out there and people have to know what you stand for. With VC being a fairly undifferentiated offering, the primary personal-brand benefit is that it helps you bring across who you are as a person, so people can understand why they may want to work with you. So I think it has become a job requirement to have a personal brand, and blogging is the cheapest and fastest path for developing it. I would also add that a VC’s overall social footprint includes Quora, Twitter, and other services, but blogging is the most substantive part.

The downside is that sometimes you are a publisher. I have landed myself in trouble sometimes because my relatively personal thoughts end up being public opinions about the industry, the economy, or startups. Blogging is a tool that requires me to be controversial sometimes, but I also have to think about the fact that I am carrying across the Atlas brand, so I have to be thoughtful. For example, there was what I considered to be a stupid article on Reuters saying that VCs are shifting from biotech to social investing, so I tweeted that I thought the article was idiotic and non-sensical. Of course it got picked up by Om Malik within a few hours, so it is very important to be careful. But overall, I don’t think there are many downsides. I mean, take a look at major influences like Brad Feld and Mark Suster. One is in Boulder and the other in LA, both of which are secondary VC markets. They have used blogging to extend their boundaries.

AP: How do you respond to people who argue that, at its worst, VC blogging creates a false impression of which VCs are the most active investors and best at their craft?

FD: There is no doubt that if you spend a third of your professional life essentially as a tech journalist, then you build a huge personal brand, and that personal brand will be leaps and bounds ahead of your “substance” as a moneymaker. And if you look at the Midas List, its all the Benchmark guys you never hear about and the Accel guys tweeting once a month who are all there and making the real money. Now take Mark Suster as an example. He’s at GRP, which is a phenomenally moneymaking fund, with partners that you don’t hear about who are making all the money. But what’s the negative against Mark for building a personal brand, helping entrepreneurs better understand the VC community, and generally making the ecosystem more efficient? So if in the process, he gets 135,000 “Likes” on Facebook, I say good for him. And he is also probably working like a dog. Fred Wilson famously blogs from 4:45AM through 6:45AM. Geez, you really need a lot of discipline to do that. When Fred Wilson started blogging in 2005 and said he would commit 20 hours per week to blogging, people laughed. Nobody’s laughing today after he’s done Twitter, Zynga, Foursquare, Etsy, etc.

AP: But what does it mean for a venture capitalist to have 135,000 Facebook fans?

FD: We have entered the age of the celebrity everywhere. There are people who are far more famous for what they say than the substance of what they have done. And there is a bit of show business in the VC industry. Entrepreneurs sometimes put people on a pedestal. So I can tell you about some entrepreneur champions involved in the early-stage ecosystem who have astonishing personal brands but are complete assholes. There is nothing you can do about them. People removed from them think they are god-like in their ability to support entrepreneurs while people who have worked with them have vowed never to work with them again. But so what? Some people play the show business game well. So if you have substance and can play the media game well, which is Fred Wilson-like, that positioning is highly sustainable. Fred Wilson not only likes entrepreneurs, but he is on the Midas List too. So this guy has bridged both worlds and created a very difficult position to assail as the go-to VC in New York. Suster has done a wonderful job of building awareness, so if he supports that by building a great portfolio, then again he will have proven people wrong and bridged the two worlds. If he doesn’t, then he will be like many of us in the venture community, a so-so VC who has done a great service to the entrepreneurship community by helping people understand how it functions.

                                    

AP: Has VC blogging truly made the VC industry more transparent to entrepreneurs? And if so, have it helped them in a material way?

FD: The transparency in general is factor of the past 10 years and not just VC blogging. This transparency really helped entrepreneurs get more sophisticated. At the same time VCs fell off their pedestals because, to a certain extent, they were not adapted to the changing times and were removed from young tech founders. So the VC as a mythological beast has been slain and replaced by super-angels, who are themselves no different from VCs, making everyone confused about definitions. But seriously, transparency has been a massive factor. Entrepreneurs now get better deals, they negotiate hard on the terms that really matter, and the social contract is a lot stronger.

I love these results because they make negotiations very speedy. It is really easy now just to tell entrepreneurs, “hey, we don’t do any of the nasty stuff you read about online, yes we will have a preference, but it will be non-participating, and no we will not have a convertible cap.” Check. Check. Check. It almost takes negotiation out of the equation because best practices pervade the industry. This is great for me but it is also great for entrepreneurs. I often hear them say, “if I had only known this 10 years ago.” In general, we are finally moving away from bespoke deals towards a liquid marketplace. This is a wonderful development because it helps people focus on what matters, which is entrepreneur-investor fit and not whether your terms make sense.

AP: It seems like some VC firms designate one Partner as THE firm blogger. Does that strategy work?

FD: My answer is that I would rather shoot myself in the head than be the designated Atlas Venture blogger. I think such a designation defeats the purpose. I am not blogging for Atlas, I’m blogging for me. I work for Atlas and love my partnership, so it comes into play sometimes. But the partnership-centric blog is a waste of time, a waste of space, and it is not what people want. They want to hear personal opinions. I sometimes disagree with my partners. I sometimes even send them messages through the blog. So we have never done that.

AP: Have any firms had success with a firm blog rather than a designated blogger?

FD: It usually fails. These company blogs always feel contrived. That being said, a few firms like Union Square Ventures and First Round Capital have done a good job using social media. That being said, if you view blogging as a dynamic publishing paradigm and think that venture should not be static, then a blog-based platform might not be a bad thing for venture firm websites. There is nothing worse than the “we update our website every five years” VC model.

AP: How powerful a tool is a VC’s social media presence for promoting his portfolio companies?

FD: There is no silver bullet in marketing. Is it helpful that Fred Wilson has 120,000 Twitter followers? I bet you it has a lot of SEO value that gets back to the companies website. I bet you it’s probably the biggest awareness impact thing the company will do that week. I think it definitely does help. I have been able to pass fairly structured messages to the press through the blog about my companies. So if a VC wants to add context to the story on one of his companies, he gets quoted on TechCrunch, which links back to the blog post. This adds a lot more depth to the story. VCs can absolutely influence the message and how its shaped.

Another thing is that if I write a blog post on one of my companies, it is hard to contradict the details I provide. If a journalist is writing a piece on the company and I have already explained the story in a candid way, people cannot go and write bullshit about the company because I am the inside baseball guy on those companies. So if you want to disagree with me, you better have good data, because my brand is based on the notion that I never lie and I don’t try to paint a pretty picture of my companies. In that way, a VC can be the author of record on his companies and cut off bullshit allegations as long as he does not sell shit himself. The VC has to be absolutely authentic. You might ruffle a few feathers, but if I have learned anything from blogging, it’s that you have to be honest.

This dialogue was originally published on Bostinnovation

A Look at Seed Stage Investing with Kent Bennett and Rob Go

Over the past year and a half, the seed stage investment ecosystem has exploded. With dozens of angels, super-angels (see Dave McClure), micro-vc funds (see IA Ventures), institutionalized seed funds (see Founder Collective), and incubator programs cropping up (see any of the billion new incubators), competition to fund seed stage deals has ratcheted up and several debates among old school venture capitalists and new wave seed investors have flared. Amidst all of this activity, entrepreneurs have an expanded set of early stage funding opportunities, which is both empowering and confusing.  With so much confusion and excitement, I decided to sit down with Kent Bennett of Sand Hill Road powerhouse Bessemer Venture Partners and Rob Go of the new Boston-based seed fund NextView Ventures to get their insights on the whole mess. 

AP: What is your philosophy on seed stage investing?

KB: At Bessemer, our typical check size tends to be in the $3-$5 million range for Series A deals with 6-8 portfolio companies per partner, so I recognize that as a larger venture firm, the very true seed stage is not often the place where we fit. Along those lines, I think all of the activity with new seed firms is great for the entire ecosystem. These seed firms help more entrepreneurs get the catalyst capital that they need to form the minimum viable product and raise more funds as needed.

RG: Both seed investors and large VCs want to find great teams going after disruptive markets with a unique and innovative product. What’s unique at the seed stage is that you have to make those decisions with much less information. For that reason, we have some core philosophies that we believe in that allow us to filter in and out companies that are or aren’t a fit for us quickly. For instance, we want to fund authentic entrepreneurs; entrepreneurs who are looking to solve a problem they have experienced in their own life that stem from things they are personally passionate about. We do not particularly like entrepreneurs who are going about it in a philosophical way. Beyond these philosophies, we also want to invest in companies that can significantly de-risk their businesses in a relatively short amount of time and with a relatively short number of dollars.

AP: As a general rule, does it make sense for big VCs to invest at the seed stage?

KB: Who knows, we’ll find out. The only thing big venture firms don’t want to do is to discourage the other seed activity out there. So for venture funds to get competitive with seed funds is not a good thing. But the two forces to come together to see more deals, that has to be great for everybody.

Will those seed funds see huge exits? For a lot of them, they won’t. There’s going to be a ton of risk in those portfolios, but it’s going to be 10 years before we find out if they pay off. Even so, because there are all sorts of halos that come off of being incredibly friendly to the seed stage deals, you could make the case that even if seed investing is not the primary financial model for big venture firms, it is still very good for them.

           

AP: Do you think seed stage investments by VCs create signaling risks for the entrepreneurs?

KB: If a VC backs a company at the seed stage but declines to make an investment at the Series A round, it absolutely sends a bad signal. But what I tell entrepreneurs is that if they take VC money and then cannot raise more capital subsequently, it is less likely to be because of signaling risk and more like to be because the product or traction just isn’t there yet. I cannot think of an example of a company with a great product and traction that withered on the vine because some investors worried about the signal.

RG: We’ve made investments with large VC funds, and the way we think about it is that we want to make investments with like-minded investors who treat every one of their investments as a true investment that takes up a full slot of time and energy for the investor. If a VC thinks about seed investments as a call option [to be acted upon later] rather than a true investment, this amplifies the signaling risk. But there are quite a few VC’s who view their seeds as true investments.

AP:  What about institutionalized seed firms? What is their role?

RG: In contrast to angel investors, the benefits of a seed fund are that it is in a better position to spend more time with the company, do thorough due diligence, and write much larger checks on a consistent basis. Versus larger VC funds, one big benefit to seed funds is that there is a much closer alignment of interests with someone who just does seed funding than with a large VC that may have multiple practice areas in terms of sectors, geographies, and stages.             

AP: How do you respond to people who argue that seed firms are creating a funding bubble?

KB: I have not seen any crazy seed stage valuations. I have seen very entrepreneur-friendly terms, primarily in the form of convertible debt, where the valuation question is put off until the Series A round. Even at the Series A round, only really viral companies in seemingly winner-take-all markets are getting particularly high valuations. And because it is easy to envision these startups as $1 billion companies, valuation is less relevant to the VC’s. What is relevant is ownership. Getting in a deal on a company you think could become worth $1 billion is far more important that the price.

RG: Ultimately you see bubble-dynamics in the pricing of investments, and there are some companies on the west coast that have insane pricing. All of our investments have very rational pricing. Frankly, I do not think there is a seed bubble in Boston and New York. And no one is forcing angels to invest in these companies, so they can always say no.

AP: What’s your view on angel investors such as Ron Conway and Dave McClure who fund 100′s of startups? Is this a smart strategy? Is it good for entrepreneurs? Why or why not?

KB: I think they are mobilizing a ton of entrepreneurship that wouldn’t otherwise be mobilized. They also have very positive signaling effects. If either of those names sign up for a deal, the deal attracts a lot more capital. With Conway, you hear incredible reputational things. He’s not just writing checks and walking away, he’s making introductions and doing other value-added things.

RG: As an LP, the question becomes “is the fund an index, and is this index interesting, or is it going to outperform an index because the investors have proprietary deal flow.” As a co-investor, my question is “how much value are they going to add.” We have done two investments with SV Angel (Conway’s fund), and Ron Conway has been able to create a very scalable way to impact his companies without taking a lot of time. You can ask almost any entrepreneur of a Ron Conway-backed company, and he will say that Ron Conway was one of the most helpful angel investors. The external perspective is very different, but ask any of the entrepreneurs. They all agree.

           

AP: The activity in the seed ecosystem has garnered a lot of press within the tech scene, but how many industry sectors does it really extend? Is it over-hyped because consumer web startups get a disproportionate amount of press coverage?

KB: The capital requirements in consumer Internet mean that there are more deals in this space that can be mobilized to a meaningful inflection point on limited capital. Those companies are also much more visible and intuitive.

RG: There has certainly been more interest on the consumer side, but there are a lot of B2B seed companies out there. In fact, at least half of our portfolio is non-consumer facing.

AP: Do you have any advice for entrepreneurs who are considering raising a seed round from either big firms, angels, or micro-VCs?

KB: Most seed rounds start from a great idea and a great team, but getting that first money in is always the toughest. I get asked “who should I talk to first” all the time, and I think AngelList is a great resource. It is a list of investors who have shown their interest to jump in at the early stage and have indicated what deals they are interested in, what sectors they look at, and so on. If you do a little digging on AngelList, you can target the angel investors who are best for your startup.

You also want to do a lot of diligence on your investor. This is someone you are probably going to live with for 5 years, so he or she needs to be someone you get along with well. Make sure you look at other angel investments he or she has made. Talk to the founders of other companies that angel has backed to see if he or she has been helpful. You want to find an angel who is there for you but not in your office everyday when you don’t need him. If I have seen any pitfall, it is when people take money from first-time investors who do not have quite enough capital to not care at all about the investment and tend to be overly involved in the business. Certainly the professional angel groups know how to manage this tension.

RG: First, and especially if you are a new entrepreneur, you want to participate in the startup ecosystem ahead of the time you start raising money, because you want investors to be able to say “this person is a known quantity, and I feel comfortable going into business with him. I have seen what he has done with his business and in other vectors of life.” I think this really helps and accelerates things quite a bit at the very early stages.  The guys at Yipit in New York executed this strategy very well.

Second, remember that you are building a company that will hopefully be around for many, many years. Because it is hard to navigate towards a quick flip you want to build an enduring company. So make sure you are working with people who you are excited about working with for the long-term. Your seed investors will be very aligned with the founders, and even if they do not take a board seat down the road, they should be able to help.

This dialogue was originally published on Bostinnovation

Post-Product Market Fit: Happily Ever After or Just the Beginning?

Until recently learning about Chegg’s growth story, I thought all of the complicated dimensions of lean startup methodology revolved around getting to product-market-fit. These issues include (1) the tension between being hunch-driven and being data-driven early on, (2) having difficulty determining whether you have actually achieved product-market-fit, (3) pivoting too much (or too little), (4) identifying whether your business fits into the special set of companies that should scale prior to achieving product-market-fit, and (5) knowing when to raise additional capital.  However, I thought everything cleared up once the business reached product-market-fit. You raise money, scale the business, and become a significant business. Game. Set. Match.

                

Of course there are several aspects of the business that still need to be sorted out once you start scaling. For example, as the class learned from a very insightful presentation given by David Skok, the business must figure out how to build a cost-effective sales and marketing machine. And the Mochi Media case revealed that even after scaling, some businesses must add features that better monetize their customers. Addressing these issues involve action-steps such as tweaking the business’ conversion funnel and adding virtual currency to the business’ product set. While these actions are important, they are tweaks rather than fundamental changes to the business model.

 And then we discussed the development of Chegg in Launching Tech Ventures (class taught by Prof. Tom Eisenmann). Here’s my version of Chegg’s history thus far:

  1. Chegg started as a marketplace for college students but was not successful
  2. With funds running out, Chegg pivoted to exclusively renting textbooks and saw positive results in 2007
  3. With these results, Chegg raised more money and fully proved that the business had reached product-market-fit in 2008 by generating $10 million in revenue
  4. At that point, Chegg raised “foot-on-the-gas-pedal” money and scaled the business to revenues of $135 million in 2010
  5. Yet, despite scaling in a major way, Chegg faces great uncertainty both because new competitors have entered its market, and more importantly, because the market and its entire value chain is about to undergo a major transformation

 

Step 5 completely upended my view of lean startup methodology. Once the business scales, everything is supposed to work itself out. However, it is only a matter of years before Chegg’s core business of renting printed textbooks vanishes entirely. This situation is very problematic because Chegg has already sunk a lot of money into the ground to scale this soon-to-vanish core business. Running it’s massive warehouse and intricate infrastructure is very expensive and necessarily influences all of the decisions the company will make. For example, even though the founders seek to transform the business into a one-stop shop for all of the academic needs of college students, they still plan for textbook rentals to remain at the core. But of course this is the plan: no one would build an expensive and currently scalable operation only to turn around and blow it up (exceptions: Netflix, IBM, others?)

      

And it is precisely this fact that slows them down and creates the opportunity for new startups to step in and eat their lunch. In other words, the founders know they must pivot, but because they are no longer lean, they are unable to pivot with speed and agility. Even if the founders do decide to blow up their current operations to meet the changing landscape, they will have to build a completely new set of capabilities. This is a scary prospect because it is very difficult for an established business, with personnel and processes tailored to specific business needs, to reinvent itself. Once again, this opens the door for new entrants.

Perhaps I am overstating the severity of situation that Chegg currently faces. The business is viral, provides high-quality service, and has garnered great customer loyalty. This suggests that switching costs may be very high. Moreover, it may be a decade before eTextbooks make the printed variety obsolete. In other words, it is entirely possible that Chegg will be a big winner.

However, the threat / opportunity created by the digital frontier has made be realize that successfully scaling the business is nowhere close to being the end of the startup story.

[This post originally appeared on the Harvard Business School Launching Tech Ventures course blog}