The scOutpost

Flipping your cost center

I've found it fascinating to look at business models that can break out of a traditional financial mold by turning cost centers into profit centers. I'm reminded of a business school classmate of mine who started a wood chip company who had a negative Cost of Goods Sold, because the wood he used was from commercial wooden pallets, and companies actually paid them to take the pallets away and "dispose" of them.

There are a growing number of companies and business models that are embracing social networks and using them to turn the traditional R&D cost center on its head. The users become the development team!
Here are a few quick examples.
Second Life : I recently talked with Philip Rosedale, the CEO of Linden Labs, and he mentioned they have the equivalent of 2700 full-time developers generating content for the game. This is a MMORPG that is unique in that all of its content is created by the players of the game. The beauty is that the development effort is coming from people who are actually paying money to the company. In a time where developing a new MMORPG costs between $20-$40M, this is a very smart approach.
Digg.com: This is a news aggregator that is becoming more and more popular. Rather than have an editor or algorithm determine what is a "top story", they let the reader community submit and review stories.
wikipedia.org. This one is a bit more obvious. Content is created and controlled by its community which is essentially anyone and everyone. The result is a fantastic comprehensive resource. I haven't seen any World Book Encyclopedia salesmen come 'round in the last few years, have you?

The trick is always seeding the community to make sure things get going, but I like thinking along this mindset of distributing the development effort in a creative, cost-effective way.

Gold Diggers and Shovels

There are many metaphors to simplify and describe life in the startup world. So, in discussing new opportunities with another entrepreneur friend, I thought I would post this framework for your consideration:
For the new opportunity, ask yourself:
1) Is it a Gold-Digger or a Shovel-Seller opportunity?
2) Which am I best at or most interested in? Is there a match?

The shovel salesman, as you might guess, sells the proverbial shovel to gold-diggers. It is easy to get into, the economics are very straight-forward and predictable, and it can grow into a nice business.
The gold-diggers have more inherent risk in what they are trying to accomplish. It generally requires more expertise to be successful and a lower percentage of them succeed. But when they do succeed, the payoff can be huge.

In today's startup world, the Gold-Diggers can be the "technology plays" that require building a technical team and proprietary technology. Most importantly, they require more funding and runway because significant revenue may not begin for 2-3 year's time. Most likely, if they succeed in their product plan, they become attractive acquisition targets in the $20-$40M range (I'm reminded of Paul Graham's great post Hiring is Obsolete). If the userbase or revenue takes off by that point, the valuation can be much higher. Business plan projections for these opportunities are super-speculative at best in the early days.

Today, in the generation of Web 2.0, it is easier than ever to create a Shovel-Seller business, tapping existing and proven markets such as online advertising, for example. Many new startups are biting into that huge market that Google's AdSense/AdWords has been in, but finding niches in some of Google's inefficiencies. You can usually get something going by cobbling together existing technology and services with a simple website and minimal team. It may not be as defensible, but at least it will be generating revenue faster to help fund market expansion efforts.

Now, evaluate yourself, and make sure your skills and desires match up. If you are a new MBA looking to apply your business skills to the startup thing, a Gold-Digger opportunity will not be a good match since the first few years are all about the technology/product and less about an actual business. If you want to have a VC-backed company or live for the high risk/high reward, then a Shovel-Selling opportunity might not be the best match since little capital is generally required to begin generating revenue. If you are great at building teams, especially technical ones, why not go for a Gold-Digger oportunity? If you want to get something up and moving with minimal hassle, try a Shovel-Seller. If you are interested in a flip, go Gold-Digger, but if you want to build a business for the long term, go Shovel-Seller. Just be honest with yourself.

The first company I started was a Shovel-Seller (although a long sales cycle made it feel like digging for gold), and the second was a Gold-Digger spending nearly 3 years building up a large core engineering team and producing some great next-generation technologies. What next? I should be held to the same standard I talking about, but I'm wondering, can I have both without sacrificing focus? With the simplicity of creating a Shovel-Seller company these days, I'm considering doing one on my own on the side while continuing the quest for the next goldmine.

That first key hire

You've got some money and the founders are ready to grow the team. Who do you hire first?  I would argue that the first key hire is a Versatile Office Manager. This person will take away many of the detailed tasks that can suck valuable time away from the founding team when they should be focused on the product/service. Additionally, if this office manager is in first to lead the future hiring charge, the whole process of hiring the rest of the team became much more organized and streamlined. Ideally, this person has the skills and attitude to play multiple roles: Office Manager, HR manager, Bookkeeper, and (if you are lucky) basic computer system administration. 

It is challenging to find the right match of skills and attitude to make sure this person doesn't feel that simple tasks are beneath them. A possible way to engage their input is to enable this person to lead the charge on crafting various policies or choosing vendors.

These days, with new communication tools making it easier to work remotely with virtual teams, the company may not even have an office yet, but many of these business operational tasks will still be there. This may not be a full-time position initially, or even after 6-12 months, but having someone around to tackle the myriad of administration and business operation tasks can help defer future and more expensive hiring in the operations area. It's all about saving time and money!