The rise of the “successful” unsustainable company

It’s appalling what passes for “successful entrepreneurship” in the press or the Valley, but it’s not their fault.

Witness, for example, this terrific Fast Company article on Bill Nguyen, serial entrepreneur who’s seventh startup “Color” famously raised $41m for a new mobile app before it even launched. (The launch, by the way, was a failure. And it’s now bankrupt.) Outspoken investor Paul Kedrosky characterizes Color’s reputation:

“It’s become a punch line. You can stand up at VC events and say, ‘Color,’ and people literally laugh without anything else being said.”

Not long ago it was the opposite. Before the doomed launch I had people asking me what I thought about Color. I said I didn’t understand what it was. They said I don’t understand mobile. They’re right, probably, but it’s not an explanation.

How did Bill Nguyen get $41m for a vague idea? Because he’s built six successful companies. Hey, actually that is a pretty good reason! How much more proof do you need that even his crazy ideas are worth backing? However he begins, he’ll pivot until he strikes gold.

Except I disagree with that definition of “success.” Here’s the summary of his track record (excerpted from the Fast Company article):

  • Forefront — IPO’ed in 1995 by CBT — CBT stock fell 85% in 1998 and prompted class-action lawsuits.
  • Freeloader — On $3m invested, sold for $38m in 1996 — shut down in 1997.
  • Support.com — On 2.5m invested, IPO’ed in 2000 for $32/share — stock price now $2.
  • OneBox.com — On $60m invested, sold for $850m 18 months after launch to J2 just before market crash — score!
  • Seven — On $60m invested, still private, cancelled an IPO.
  • Lala — On $35m invested, sold to Apple for $80m — shut down in June.

The pattern: Build up a business, create impressive shareholder value, then it fails.

You could argue it’s not Nguyen’s fault that his acquirers mishandled his babies. But really, are all those acquirers so stupid? Surely not. After I sold Smart Bear, that division has increased revenue and profit every year, for five years, even through the 2008/2009 economic disaster. And the same thing happened after we sold IT WatchDogs in 2005.

The crap of it is, those VC’s who continue to invest in Nguyen are acting rationally. After all, before the house of cards inevitably tumbles, private equity investors get a tidy return. Nguyen knows how to keep the magic going long enough for the payday.

And it is magic. When you read quotes from people who’ve worked with Nguyen, ask yourself whether he’s driven by truth or deception:

“Many salespeople blur the line between reality and potential to move a deal forward. Bill seems to delight in willfully disregarding the line altogether.” –unnamed source for Fast Company

“He paints pictures with the best in the world, And storyteller doesn’t give it the richness it deserves. He’s Jobsian in his ability to get you on his side.” –Geoff Ralston, Lala’s CEO, board member Color

“Bill is able to say something and have the person he’s talking to believe it, and believe that they want to buy it. … He has what I call ‘the Jedi.'” –Ross Bott, CEO of Seven,  former CEO of OneBox

But to me the bigger problem isn’t with deceivers, but rather with what Dan Lyons characterizes as the rise of unsustainable companies which people honestly believed were sustainable.

Like Groupon, with a product that everyone agreed was brilliant, spawning 1,000 copy-cats.  But all that investment in growth and sales force didn’t have a long-term payback, and the actual value of the product to small businesses wasn’t as high as claimed, even though the simplest of customer development reveals this fact (ask any restauranteur).  So it IPO’ed at a $13b valuation but has dropped month-over-month to one-fourth that value and appears to be in “constant pivot mode” while they try to figure out a new, massive market for which their existing infrastructure is an asset.  In other words, they’re back to seeking product/market fit, and only an immense market (and excellent fit) will counterbalance their crushing costs and pay back past investments.

Or like Zynga, a smart, seemingly unstoppable Facebook game company, whose individual product successes are fleeting, who were financially successful at a certain scale, but it’s doubtful they can continue innovating enough games to justify their current size. And when someone else succeeds in their space (e.g. Draw Something), they buy it as it immediately fades in popularity and thus in value (e.g. Draw Something, bought for $200m and lost 5m active users one month after).  Which explains why their stock price is at $2.43 from an IPO under a year ago of $10.

The thing is, these companies are not like Nguyen’s Color. For years they demonstrated real, growing revenues (not just “active users”), a repeatable, scalable business model (not just flash-in-the-pan ideas), ownership of a large market (SMB lead-gen, social gaming), and they survived the operational challenges inherent in rapid-growth companies.

These are all the substantial things we want in healthy companies, and yet it seems to me they’re either more short-lived than we’ve all thought (i.e. that “Facebook games” is a fad rather than an industry) or that executives and investors are over-eager to value growth over sustainability (i.e. Groupon’s engine that turned capital into revenue growth was a form of force-feeding rather than building a product).

Of course this is hindsight-based armchair speculation, easy to do from the comfort of a blog post. On the other hand, I do see companies that are sustainable even with high growth, like HubSpot whose revenue curve is as predictable as a plot on your TI-90 while also able to obsess over customer satisfaction and retention, or like Freshbooks who maintains an enviable corporate culture in addition to an unflagging revenue curve, or like SEOMoz whose insistence on TAGFEE wins over employees, customers, and investors alike, creating consistent growth even in the tumultuous market of SEO tools, or like Rackspace whose maniacal obsession with excellence in customer service allows them to charge premium prices and sustain an amazing 30% annual growth even at the massive scale of $1b in revenue.

Note that some of those companies were bootstrapped, some bootstrapped and took money later, and some had huge funding from the start. It’s not about the financing path, it’s about what you’ve decided to build.

It’s my goal to join the ranks of those excellent companies at WP Engine. With thirty employees, millions in revenue, a Rackspace-like commitment to customer service (we employ more WordPress experts per 1000 customers than anyone),  an SEOMoz-like commitment to honesty and transparency, and a HubSpot-like obsession on introspective measurement, not just on marketing and growth but on customer happiness and retention, we’re experiencing fantastic growth, but in a way that I believe is sustainable.

So now it’s your turn to think about this with your own company. Is your company building something of lasting value? Are you valuing growth over sustainable growth? Are you articulating and then living up to company-cultural values which attract and retain the right sort of people who then turn around and create the right sort of product and service?

If you know you’re building a flash-in-the-pan, like a cool mobile app, than that’s fun too of course!

But if your goal is to build a lasting company, be honest about what “lasting” means. Growth is necessary, but not sufficient.

  • Dale

    Yeah, I’m a little discouraged that new businesses are measured by how much funding they’ve received. Jim Jones of Company XYZ was named entrepreneur of the year. His company raised $80M in funding. Great, how much money did he MAKE?

    And this selling to Google model… is this good for the economy to have millions of dollars in value just go away?

    When people classify my ventures as “start-ups” I always make sure they know I’m in it to increase cash flow, not get funding or sell to Google.

    • http://blog.asmartbear.com Jason Cohen

      Don’t assume that selling to Google means less money in the economy. Google is much more able to monetize talent (and certain products) than startups. It’s easy to say “what if that company created $1b in value by itself over the next 5-10 years,” but it’s more likely that the company will be out of business in that timeframe, and more likely that Google will be able to grow by that amount of value in that timeframe.

      I’m also not advocating that this is a *better* outcome, just that making blanket statements about what’s “good for the economy” is tricky.

  • http://www.virtuallybing.com/ Bing Chou

    As you say, investors are acting rationally here. As long as VCs can continue to cash out before the music stops, we’ll continue to see VC fueled companies with shaky business models sputter out.

    • http://httpcolonslashslashwww.www.startupjerkfest.com StartUpJerkFest

      the bigger fool theory. sell to some one else before it crashes.

      • http://www.linkedin.com/profile/edit?trk=hb_tab_pro_top Russell Himelein

        i think the most interesting question is how do you go about discouraging or dis-incentivizing the ‘bigger fool theory’?? or i guess put differently incentivize LT value over ST ‘disguised egos’ and further fundings of the colors of the world…. How do we get more companies to join the ranks you described

        • http://httpcolonslashslashwww.www.startupjerkfest.com StartUpJerkFest

          i don’t think its possible, built in human condition to look out for #1

        • http://ludovicurbain.blogspot.be/ Ludovic Urbain

          Actually, it’s easy but it has a lot of side-effects.

          Education will fix that for you, along with mostly everything that’s broken in this world.
          So please, get involved and make this world (full of) better (people).

          The only solution to prevent abuse of stupid people is to prevent stupid people, anything else is clearly impractical.

        • http://steamcatapult.com/ Dave Pinsen

          “i think the most interesting question is how do you go about discouraging or dis-incentivizing the ‘bigger fool theory’??”

          Aftermarket stock market investors have been doing their part. Next, mutual funds and other institutional investors in public equity need to be more judicious in buying the IPOs. If they do, that will force late-stage VCs to be more judicious, and so on, with a ripple effect down to seed stage investors.

        • http://www.salesprocessengineering.net Justin Roff-Marsh

          Who is the “you” who you propose should dis-incentivize the fools’ foolish behavior?

          And why would the natural consequences of foolish behavior not be dis-incentive enough?

          There’s an interesting argument (bubbles, creative destruction, etc) that this kind of frenzied speculation actually benefits the market sector by flooding the ecosystem with cash.

          I think the take-away is that we should focus on building companies like Rackspace (rather than Color) — but take full advantage of the frothy market conditions when they present themselves.

          • http://www.linkedin.com/profile/edit?trk=hb_tab_pro_top Russell Himelein

            All I’m saying is I wish the ‘frothy mkt’ would push more cash towards the wp engines of the world vs colors and am curious what would incentivize that. I agree a flood of cash isn’t the worst thing but wouldn’t it be better in the hands of more companies creating sustainable growth vs speculative gains??

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  • http://www.facebook.com/stevenIBenjamin Steven Benjamin

    maybe it is just me, But if a company can’t provide value to a small customer base, how can it provide value to a large one?

    • http://blog.asmartbear.com Jason Cohen

      Many companies are that way. Any marketplace generally has value only at scale. Any network-effect company has more value at scale.

      Of course the good ones deliver value before scale, i.e. Skype is useful for Skype users even if no one else is on Skype. But Skype is far more useful when everyone is on Skype because most people can’t afford the telephony costs of not doing Skype-to-Skype calls. (Which they subsidized for years, which cost tons of money, because it got them to scale, which is where they’re valuable.)

      • http://www.facebook.com/jason.r.coleman Jason Coleman

        Skype has a single player mode.

  • bsbechtel

    Jason, this is an excellent article. As always, hindsight is 20/20, but you make some good points.

    With the exception of Facebook though, all of the sustainable companies you mentioned are B2B, whereas the companies that crashed and burned tend to be B2C (I would consider GroupOn B2C, despite their revenue coming from businesses).

    I’d say this is an indicator of fickle, changing consumer demands, where businesses tend to have more stable needs, which can lead to more sustainable businesses serving those needs. This may be an additional point worth considering when evaluating whether a company is actually a sustainable business or a flash-in-the-pan.

    • Wilkerson

      I may sound ignorant here, but what is B2B and B2C?

      • http://blog.asmartbear.com Jason Cohen

        B2B means “business that sells to other business” where as B2C means “sells to consumers.”

      • http://www.speak2bfree.com/blog Vangile Makwakwa

        b2b is business to business and b2c is business to consumer

    • http://httpcolonslashslashwww.www.startupjerkfest.com StartUpJerkFest

      yes, but there are many B2C companies that are still in business after their startup days long ago, i.e. McDonalds, Supermarket chains, etc. They are doing something right, find out what and learn from it.

      • tashpop

        they are selling real products (food) and that doesn’t change much whereas apps, technology solutions, platforms are ever changing and trend based so very volatile

    • http://blog.asmartbear.com Jason Cohen

      That’s just an accidental artifact of the two examples I chose.

  • jwb

    Say what you will about the rest of that junk, but lala was a truly great product that Apple happened to strangle.

  • ronclabo

    Jason – Great post. This article reminds me of another thing that bugs me alot: entrepreneurs that behave like their funding round is proof that they have “arrived.”

    Raising funding, no matter what the amount, doesn’t mean that the company is going to succeed. It just means that the venture now has more resources to execute their model _and_ they have more pressure to do it fast so the investors can get the return they are looking for.

    If we could all stop being enamored with funding rounds and those who raise them, we could more clearly see that firm capitalization isn’t any more important than selecting an appropriate target market, and it’s less important than creating real value for the end customer.

    -Ron

    • http://blog.asmartbear.com Jason Cohen

      Right. A better question is what the money is for.

      If the company could stop all marketing and on-boarding spend and be profitable, then you can easily argue that the funding is for growing something that is profitable, but where we want to get larger in exchange for money now.

      If the company just isn’t making any money, and especially if there’s no evidence how it will every make (enough) money, then the funding round is just more time, and not an indication of sustainable success.

      • http://twitter.com/LeanLearnin Brent Weber

        Exactly right.

        If the money is “seed” money, not impressive. If it is for designing the rocket, that is a little better.
        I would rather see companies bootstrapped then pursue a modest amount of funding to build and light the rocket.

  • http://twitter.com/scottporad Scott Porad

    Jason–

    What’s interesting to me about the above paragraph is the reference set: HubSpot, Freshbooks, SEOMoz, Rackspace.

    It’s interesting to note that none of them are media or platform companies. They are all companies that charge their customers for a service they provide.

    Who would be in that set if we were looking at platform or media companies?

    • http://blog.asmartbear.com Jason Cohen

      Platform is easy: Heroku, Amazon AWS, Twilio, etc..

      Media companies I’m just not as familiar with. However most major publishers are in fact that way. Just because many aren’t changing with the times doesn’t mean they weren’t companies with staying power. Many lasted decades. Everything comes to an end but still they were clearly sustainable for any meaningful definition of the word.

      • http://twitter.com/scottporad Scott Porad

        So, first, per the comment you left at my blog, http://www.scottporad.com/2012/10/23/growth-is-necessary-but-not-sufficient/#comment-12857, I did not think you were suggesting media companies ought to be excluded. I just was making the observation…no offense taken, feathers ruffled, etc.

        Now, back to the substance, looking at platform and media is interesting. Again, platforms are getting paid by their customers. But, both of us struggle to think of “new media” companies. AOL and HuffPo is the best I can come up with. (And, obviously, Cheezburger, but I can’t honestly say that we’re there yet.) (And I must admit I’m feeling sheepish for drawing such a blank!)

        Perhaps the distinction isn’t service vs. product vs. platform vs. media, but rather direct revenue (i.e. your customers pay you) vs. indirect revenue (i.e. advertisers pay for access to your customers).

        Anyhow, it’s an interesting observation. I’m looking forward to other commenters ideas.

  • DJ

    Heh, I remember waaaay back when Freeloader launched. I downloaded it and thought it was going nowhere. Then AOL bought it three months later and I thought “I gotta get in on this Internet thing.”

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  • Joni S.

    No offense, but referring to your comment on Color – I don’t know what WP Engine does, even after visiting the website :) Isn’t it like getting hosting from WordPress.com? What’s the difference? Why should I care?

    • http://www.facebook.com/john.r.reeve John Reeve

      WPE is different in that each wordpress install is its own set of files rather than using a multi-site kind of setup as with wp.com. Basically (and this is after) having a couple of client sites on it, it feels easy enough to use, kind of like shared hosting but seems to perform a lot better. Actually, I have gotten better performance on WPE than on a VPS for the same site… but I think that’s most of it.

  • http://twitter.com/RichUnfamous Richard Speigal

    I’d like to say a massive THANK YOU for this post! Many many of us have been uncomfortable about tech’s desire to circumvent the rules of business (ie being profitable, lasting more than 2 minutes and paying taxes). Finally someone pulled this guy and the industry up on it. You’ll take some crap for this, but your post is long overdue. Good work.

  • http://twitter.com/ShopDiscoveries Shopping Discoveries

    Very true. Awesome post.

  • johndurbinn

    This is why liberalism needs to be called out as being a mental disease. Liberals have no concept of value, and think that buying and spending their way out will lead to economic success. Reason 1,000,001 that obama needs to lose his job nov. 4!

  • http://twitter.com/JosephPutnam Joseph Putnam

    Hi Jason, I love this post. This weekend I started “Good to Great” by Jim Collins. Your reference to Bill Nguyen and the companies he started remind me a lot of the comparison companies that didn’t do as well as the companies profiled in the book that went from good to great. One group focused on short-term growth and profit, the other focused on sustainable growth and profit. As an entrepreneur, I’d much rather be in the second group since it’s the responsible and profitable thing to do. Thanks for the reminder.

  • http://twitter.com/austingunter Austin W. Gunter

    I’ll weigh in as well.

    To echo this as one of those 30 employees at WP Engine, Jason leads the company with the values he espouses above. The growth of any startup is super challenging, but as a company, WP Engine is focused on building something that not only is profitable, but
    also creates opportunities for our customers, and we’re only successful when they are.

    Of course, I’m also self-interested. I want to I start something of my
    own in the future. Until then, I’m getting to be part of a sustainable
    company tha will rub off on my own efforts in the future.

    Also, relevant:http://techcrunch.com/2012/10/23/zynga-ceo-mark-pincus-confirms-layoffs-5-of-workforce-potential-closures-for-u-k-japan-offices/

  • http://bretthard.in/ Brett Hardin

    Upon seeing the FastCompany article before reading this, I thought some of the same thoughts. Thanks for wrapping up some feelings I have had for a while Jason.

  • http://twitter.com/RAFraudwha Rage Against Fraudy

    Another conman sucks America dry.

  • dkural

    Some theorists say that all companies of any size are ultimately unsustainable and represent an ultimately temporary arbitrage opportunity; eroded over time; where the costs of coordination overwhelm the margin of profit. Check out work by Geoffrey West. Essentially its all a glitch in efficient markets – perhaps lasting for a long time, but ultimately eroded. The only model for lasting forever would be sustained innovation & reinvention (basically constantly reinventing your business); and it is hard to beat rest of the world on any twenty-year period. (i.e. much more likely you’ll end up like zynga – overpaying on the tail end, or groupon – constant search to sustain scale).

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  • http://www.slavoingilizov.com Slavo Ingilizov

    Something is not quite right with the HTML of your blog. There’s a large iframe that prevents me from clicking links. Check your Facebook share button: http://screencast.com/t/NL8fGfOG0

  • http://ludovicurbain.blogspot.be/ Ludovic Urbain

    I think the biggest problem is that even you see the wrong companies as sustainable.

    Facebook is not sustainable.
    (because it’s a winner takes all market, and facebook has stopped expanding at the 1 billion user mark, all the while pissing its users off with advertisement and the lack of privacy related to US policies)

    SEO is not sustainable.
    (because it revolves around search engine algorithm weaknesses and the current state of the economic web, very very temporary)

    Dropbox is not sustainable.
    (because very soon everyone gets free space/sync from other services providers, and dropbox is not worth the hassle anymore)

    Twitter is not sustainable.
    (like facebook)

    And by the way, wordpress is not sustainable.
    (it will soon be replaced by something just like it, just a bit worse and easier to use)

    All those things are quite clear when you look at the nature of their business, but some choose to ignore that, because there’s more than enough profit in the coming years to justify it.

    And like everyone of the frauds you listed, it was over hyped by VCs, for VCs, and poor (and dumb) people ended up owning worthless stock in companies they did not understand.

    The whole Silicon Valley startup factory is about unsustainable business and growth.

    All the while, AMD market cap is down below its annual sales, without any consideration for the whole graphics part of the business, IP, cash and everything.

    Investors=noobs.

  • Speaksintech

    What about the “Scoble Effect” of pumping up interesting startups without understanding the business value they create?

    • johndurbinn

      scobles a fucking buffoon. anyone who listens to that idiots ramblings deserve to lose every penny

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  • jasonstoddard

    The irony: This post, and those like it, are like a startup with a similar business model (as described). Successful conversation; not sustainable.

  • Frank

    An error in the article: Onebox.com was sold for $850M to Phone.com (which later became Openwave Systems). It was a couple years later before J2 (Jfax/Efax) acquired Onebox.com.

  • brianzeligson

    How much do you know about Freeloader and Lala? If those were acquihires, I’d still agree it’s not a “sustainable business,” but it wouldn’t necessarily attach deception to the process. Plenty of companies are bought and shut down for the talent alone.

  • http://twitter.com/aaronwall aaron wall

    Give it 10 years and some seemingly “successful” companies might end up showing the same unsustainable behavior after the fact. The big differences in terms of growth curves & leverage are
    – free vs paid
    – b2c vs b2b
    Paid b2b products/services have a naturally slower growth curve than free b2c services. There are still ways many companies fueled by growth can suddenly hit a bump that derails them. For example, a year ago some people would have included Zynga in a list of the successful companies, but after they hosed some acquisitions & saw lower uses + higher customer acquisition costs their enterprise value tanked. And when that happens there can be a talent drain & other knock-on impacts. B2b subscription revenues certainly are more sustainable and predictible than ad revenues, but companies that are debt-leveraged for growth or have investors who want to bet the farm can still easily blow up.

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  • tashpop

    Consider this; Germany vs China vs US… German economy is growing because they engineer and build. China has grown because they manufacture. US is volatile cause its focused on technology solutions and these tech app platform and ‘solutions’, just like the ones you talk about here.

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  • dpgj

    There are just too much money floating around that looking for yield. Even IT people do not understand the market and it is very natural that VC know even less. With those IT “innovator” who know how to talk to the VCs, getting the money is easy enough. There are always parasites living in between living organism and nutrition. The catch is there were so few successful innovations while these successful innovations earned huge.

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  • Guest

    Sorry 4 teh spam

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  • Tamra Heathershaw-Hart

    I wonder how often investments into the unsustainable companies are for other reasons than ROI — most of those investments got good press coverage, and they definitely gave the investors access to the startup’s pool of talent. And even though I personally find the total amounts invested in certain startups easily reached the point of being silly, that doesn’t negate the fact that the money paid people and bought items. Sadly, it’s often true that the best an entrepreneur can do in the modern economy is to feel proud of having paid someone a decent salary for as long as they could.

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  • http://twitter.com/IanDSmith Ian

    Jason
    A very good “burst the bubble” type post. I wish we had more. In my current role, working with CEOs to scale their business as their COO (3 clients) I define Growth and Scaling as different things. Scaling is not growth. Scaling implies alignment, control, repeatability, aggressive growth but safely. I’m convinced that most of the Inc 500 are growing not scaling.

    Best Ian

  • http://twitter.com/kitode Jessica Margolin

    It’s about intangible assets, particularly the (in)ability to account for them. (For the thousandth time…) For example: Groupon’s model was flawed. You have to give deep discounts for trial, but you don’t want to be obligated for unlimited trial. It’s impossible that they didn’t have this feedback from their customers. What *is* possible is that they didn’t listen. Zynga had the reputation of a sweatshop. If your business model requires exploitation, then as soon as you stop exploiting you don’t have a working business model. You stop being able to innovate. You buy competitors and they don’t want to work for you.

  • http://www.speak2bfree.com/blog Vangile Makwakwa

    In the VC world Bill Nguyen is successful because they get to cash out at high returns. After that it’s the shareholders’ proble.These are questionable ethics and it begs the question: do the VCs know that the business models of these companies are flawed? If so why do they sell them and have IPOs?

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