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Joseph Schumpeter said in his theory of “creative destruction” that the “process of industrial mutation…incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”

I believe we’re approaching a sea change in retail where physical retail is displaced by e-commerce in a multitude of categories.  The argument at a high level:

  • Online retail is relentlessly taking share in many specialty retail categories, resulting in total dollars available to physical retailers stagnating or even declining.  This is starting to put intense pressure on their top lines.
  • Physical retailers are very highly leveraged and often have narrow profit margins.  Material declines in their top lines make them unprofitable and quickly bankrupt.
  • Online retail will benefit greatly from the elimination of their physical competition and their growth should accelerate.

Let’s start with the historical context.  What’s been happening in retail in recent decades is a perfect example of creative destruction in action.  In a little over a half century, multiple generations of specialty retailing concepts have been created and subsequently destroyed.  The widespread building of large suburban shopping malls after World War II led to the development of the specialty retail chain store, at the expense of independent, sub-scale “Main Street” retailers.  A few decades later, many of these mall-based specialty retail chains were in turn crushed by the development of “big box” retailers, who had had substantial cost, pricing and selection advantages.  And currently, many of these big box retailers have been in turn devastated by the rise of e-commerce and its substantial capital and cost advantages.  E-tailers don’t need to build, rent, stock and staff a large chain of individual stores; instead, they enjoy significant efficiencies from centralization.  An example of their relative efficiency can be seen in labor: Revenue per employee for Amazon is $0.9 million per year vs. $0.2 million at Wal-Mart.

Book retail provides a good example of this evolution.  Independent bookstores gave way to mall-based chains like B. Dalton and Waldenbooks in the 1960-70’s, who in turn gave way to big box chains like Barnes & Noble and Borders in the 1980’s, who in turn are giving way to e-commerce players (particularly Amazon).  B. Dalton, Waldenbooks and Borders are now out of business, and Barnes & Noble is struggling to morph itself into an e-commerce and e-book company before its physical bookstore business evaporates.

I believe that the demise of physical bookstores is just the canary in the coalmine for all of the big box players, and that the same creative destruction will play out across specialty retail.  It’s already happened in music and video retail: Tower Records, Virgin Music and Blockbuster Video are all history.  And it’s starting to happen in other categories.

The steady, relentless share gains of e-commerce have been widely documented.  According to the U.S. Census Bureau, e-commerce had grown to 7% of total retail by 2010.  But there is wide variation in online share by category:

Source: U.S. Census Bureau, Annual Retail Trade Survey

The large “supermarket” categories of Food & Beverage and Health & Personal Care have tiny online participation, but the specialty retail categories have large and rapidly growing online shares.  And the huge category buckets reported by the U.S. Census probably obscure the magnitude of some of the share impacts.  For example, the bulky, heavy appliances in the “Electronics and Appliance” bucket probably haven’t gone online as fast as electronics, suggesting that online share in electronics is probably much higher.

And things get even more interesting when you look at this in terms of dollars, such as in the Electronics and Appliance bucket:

Source: U.S. Census Bureau, Annual Retail Trade Survey

Total category sales have stalled over the past half decade, likely impacted by the housing bust.  But the steady growth of online is causing the portion of the market available to offline retailers to be substantially pressured.  Total offline sales among all Electronics and Appliance retailers were lower in 2010 than they were in 2004!

So, imagine you are Best Buy.  They are the leading electronics retailer in the U.S., and they also sell computers, media and appliances.  They historically have been among the most innovative and successful of the big box retailers, and were named “specialty retailer of the decade” in 2001 by Discount Store News. Between 1998 and 2008, they ripped off 10 straight years of positive comp store sales growth; compounded, their comp store sales were up a staggering 75% over this period.

But as we see above, the portion of the market available to offline retailers in Best Buy’s verticals is shrinking due to withering competition from online players with substantial price and selection advantages, exacerbated by “show-rooming” enabled by mobile devices (see my previous post about Belly).  Best Buy’s amazing 10-year run in comp store sales growth screeched to a halt in 2009, and they’ve had negative results three of the past four years. Many of their offline competitors have already gone out of business, as No. 2 player Circuit City did in 2009.

You get a sense for the hurricane that Best Buy is trying to navigate when you look at their performance by category:

Two-year
Compounded
Comp Store

Ending
Revenue

Category

Change

Mix

Consumer Electronics

(11%)

34%

Computing and Mobile Phones

2%

43%

Entertainment

(37%)

9%

Appliances

13%

6%

Services

2%

7%

Other

1%

Total

(7%)

100%

Source: Best Buy

It’s flat out brutal when your #1 and #3 categories have dropped 11% and 37% respectively in just two years.

Once upon a time, I was CFO of The Disney Stores Worldwide.  One thing I learned there is that physical retail is very highly leveraged as a massive chunk of the expense structure is fixed.  Each store typically has a long-term lease with fixed rent payments and requires minimum staffing and inventory to operate.  And stores require warehouses and trucking fleets to house and transport inventory, and central staffs to manage it all.  Due to these high fixed costs, even small changes in comp store sales can enormously impact profitability.  I experienced this in vivid detail at The Disney Store.  We enjoyed record profits behind surging merchandise sales for the run-away hit “The Lion King” in 1994, but the following year’s results were hammered by anemic product sales for the much-less-successful “Pocahontas”.

Relatively small declines in comp store sales, if sustained, can quickly prove fatal to physical retailers due to this leverage.  The Circuit City example is instructive here. Their bankruptcy was preceded by just six quarters of declining comp store sales.  They essentially broke even in their fiscal year ending in February 2007; they declared bankruptcy in November 2008 and started liquidating in January 2009.  It is also notable that Circuit City’s bankruptcy has had only modest benefit to Best Buy, as did Borders’ bankruptcy for Barnes & Noble.  Not even the elimination of the largest competitor provides material reprieve from brutal market headwinds.

Here is the case for e-commerce acceleration.  Continued share gains by e-commerce players shrink the pie available to physical retailers.  Marginal physical players go bust, providing only a temporary boost to the remaining offline players and a sustaining boost to online players.  But the underlying market dynamics stay the same, and pressure again builds on the remaining physical players.  When their top-lines drift below their highly leveraged water lines, they too drown and liquidate.  At that point, e-commerce becomes about the only place where consumers seeking a broad selection of merchandise can go.  They essentially run unopposed.

This Darwinian struggle for survival has already played out in music and is in the last act in books and movies.  In electronics, Best Buy is the last man standing and the pressure is building.  They have virtually no margin for error as their operating margin is down to 2%.  When they succumb (and unfortunately for them, I believe this is a “when” and not an “if” unless they are able to pull off a radical transformation of their model), e-commerce will become the only place to find a comprehensive selection of electronic products.  And other specialty retail categories like apparel and home are not that far behind their media and electronics colleagues.

We’re extremely bullish on the prospects for e-commerce, and we’re very bearish on the prospects for offline retailers who compete head-to-head with them.  The implications are broad.  To paraphrase Schumpeter: We believe that offline retailers that cannot deliver a differentiated value proposition to consumers will be destroyed by a new generation of online retailers that is being created before our eyes.

On a final note… I’d like to thank my colleague Wei Lien Dang, who provided strong analytic support for this post.

The Net has unleashed unprecedented price transparency across both online and offline worlds.  Comparison shopping engines offer convenient price comparison for goods across online retailers, helping consumers easily discover who has the lowest prices online.  People are “show-rooming” (i.e., visiting real-world stores to physically evaluate products), but then using their smartphones to research the lowest price and often buying the item online.  And daily deal sites bring transparency to deep discounts offered by local offline retailers, helping to lure bargain-conscious shoppers attracted to bargain basement prices.

Competing simply on price is a really tough road for the vast majority of merchants.  There can only be one low cost provider in any market, and price competition can result in Darwinian struggles for survival.  A few decades ago, big box merchants like Walmart used their cost and selection advantage to severely undercut mom and pop merchants and forever change Main Street.  Some of you may remember the movie “You’ve Got Mail”, where Tom Hanks’ big box bookstore put Meg Ryan’s quaint bookshop out of business.  Well, a sequel must be brewing because Internet retailers like Amazon are using their cost and price advantage to crush those same big box bookstores…and music stores…and computer and electronic stores.  Most of the once highly competitive physical chains in these verticals are history, and the few remaining holdouts like Barnes & Noble and Best Buy are desperately fighting a pretty inevitable extinction.

Merchants are desperate to find ways to compete outside of direct price competition.  Enter the loyalty program.  All sorts of retailers have loyalty programs, be they the nearly ubiquitous punch card from your local sandwich shop or more elaborate programs from large offline and online retailers.  Some of you may recall the famous Seinfeld episode about George’s enormous wallet, which was filled with loyalty cards from half the retailers in Manhattan.

A set of new companies is seeking to bring digital efficiency to the loyalty programs of offline merchants, leveraging a combination of the Net, mobile devices and data analytics.  Instead of carrying a wad of cards from individual retailers, people carry one card or one smartphone app that can be used at multiple participating merchants.  Instead of manually tracking visits, merchants rely on smartphones and tablets to digitally record the visits.  And instead of merely redeeming paper cards, merchants tap this digital information to really understand their customer behavior and the identity of their best customers.

Andreessen Horowitz is proud to announce our most recent investment in one of the market leaders in the emerging loyalty space: Belly.  We elected to invest in Belly for the following reasons:

  • They have a talented and committed management team, led by Founder and CEO Logan LaHive.
  • Belly has built an elegant product that fully leverages emerging trends in mobility.  Every merchant has a consumer-facing iPad at their cash wrap that actively promotes their rewards through Belly, and in the mechanism through which consumers check in.  And consumers can check in at Belly using either a smartphone app or a physical card. Belly also brings an approach to loyalty that goes well beyond simple “buy x times and get y”.  They work closely with every merchant to develop rewards tailored to that merchant’s unique attributes, integrating many non-financial rewards that bring out the personality of the business.  A couple of my favorites include “name your own Slurpee” at 7-Eleven in Chicago, “cut the line” at Southport Grocery, and ”win an ice cream date with Jerry (yes, that Jerry!) from Ben & Jerry’s in Washington, D.C.”.
  • Belly is attacking the market aggressively and has already signed up over 1,400 merchants and 200,000 consumers since launching last August.  This is not particularly surprising as their original funding came from Brad Keywell and Eric Lefkofsky at Lightbank, whose investment Groupon acquired merchants at a blistering pace.  We are psyched to work with Brad and Eric on Belly.
  • We believe having a large, connected network of merchants and consumers affords interesting opportunities beyond loyalty programs down the road.

I’m proud to join Belly’s board and will be actively working with the Belly team on a rewards program for achieving their key milestones.  My current favorite: The team gets to pie our own Mr. Andreessen after adding their 10,000th merchant (an option I have yet to share with Marc—we’ll soon see if he reads my blog posts!).

We are delighted to announce that the six General Partners of Andreessen Horowitz, with our families, are all committing to donate at least half of all income from our venture capital careers to philanthropic causes during our lifetimes.

The reason is simple.  We are fortunate to work with some of the best entrepreneurs and technologists in the world, and in the process help create great and valuable companies.  That activity, done well over decades, can generate a lot of money that can then be productively deployed philanthropically back into the society that makes it all possible.  We love participating in this process, and we hope that our philanthropy can, over time, help make the world a better place.

As an initial catalyst, we are making an immediate group donation of $1 million to a set of six vital Silicon Valley-related nonprofit organizations.  Those causes, and their respective sponsors, are:

Ben and Felicia Horowitz: Via Services
Jeff and Karen Jordan: Ecumenical Hunger Program
John O’Farrell and Gloria Principe: Second Harvest Food Bank
Marc and Laura Andreessen: Fresh Lifelines for Youth
Peter and Martha Levine: Canopy
Scott and Pamela Weiss: The Shelter Network

Signed,

Ben, Jeff, John, Marc, Peter, and Scott

[popover_trigger handle=”Right-Above-It”]Facts are simple and facts are straight
Facts are lazy and facts are late
Facts all come with points of view
Facts don’t do what I want them to
—Crosseyed and Painless, Talking Heads (written by Brian Eno and David Byrne)

[/popover_trigger]

[popover_content handle=”Right-Above-It”]Artist: Talking Heads
Track: Crosseyed and Painless
Album: Remain in Light
Released: 1980
Label: Sire[/popover_content]

[single_grooveshark code=”hostname=cowbell.grooveshark.com&songIDs=247900&style=metal&p=0″ width=”150″]

Business growth at established companies tends to fall relentlessly over time in the absence of inspired innovation, an impact I affectionately refer to as “gravity”. If a CEO wants to fight this gravity and improve the long-term growth trajectory of his or her business, he or she needs to take proactive, concrete steps to make it happen.

As CEO, I was always trying to develop and test a portfolio of potential new initiatives to support business growth, targeted at both optimizing the core business as well as adding new layers of growth (see my last post on this topic about Adding Layers to the Cake). I wanted to identify completely new initiatives that would boost business growth—things we weren’t already doing. Things you are already doing are largely yesterday’s news, and their impact on future growth tends to wane over time. Implementing completely new innovations can help your business fight gravity.

At OpenTable, one of the most highly leveraged examples of an innovation to optimize our core business was developing a rigorous methodology to pursue and assess potential site improvements. A while after I became CEO of OpenTable, my predecessor Thomas Layton (who did a spectacular job positioning OpenTable for long-term success) sent me a fascinating video of a guy named Ron Kohavi talking about Amazon’s approach to something he called data-driven product development. Here’s an old link to one of his presentations (FYI, it only works sporadically): http://videolectures.net/kdd07_kohavi_pctce/.

The video details how Amazon rigorously deployed A/B testing to optimize website efficiency. Kohavi starts the presentation by showing a number of different executions of the same feature that they had tested over time, and he asks viewers to vote on which they thought had performed better. The results suggest that the folks in the audience—all website geeks—were not able to consistently pick the winning execution. That was mildly surprising. But what was astonishing was the delta between the results driven by different executions of the same feature: what often appeared to be subtle changes could drive huge improvements in performance!

In the video, Kohavi also talks about the impact of the “HiPPO” (Highest Paid Person’s Opinion) in the product development process. Not surprisingly, most HiPPOs believe that they know intuitively what will work best (spoken by the former HiPPO at OpenTable). But pretty much none of us have the product instincts of a Steve Jobs, and Kohavi makes a very compelling case for letting the data and not the HiPPO make the decision.

So we resolved to test data-driven product development as one of OpenTable’s potential core business optimization initiatives. We tasked a talented product manager, Julie Hall, to lead the effort and we procured tools to inform the effort. For the art side of the effort, we found the low-cost and highly efficacious usertesting.com service that enabled us to get qualitative user feedback literally overnight to inform what we planned to test. And for the science side, we bought the overpriced but also highly efficacious “Test & Target” system from Omniture (developed by Offermatica, now owned by Adobe) that enabled robust quantitative measurement of a number of simultaneous A/B tests.

These two tools worked together marvelously. One time, we literally stumbled upon a big “improvement opportunity” (a.k.a. a nasty usability problem on the site). We used usertesting.com to task a handful of unregistered users with making a reservation. But we watched in horror as a significant minority of the test users got trapped in our “Sign-In” functionality and couldn’t complete their online reservation. In the real world, they would probably get pissed off and simply pick up the phone (OpenTable’s biggest competitor for consumers) and call the restaurant, a disaster for our user acquisition, brand affinity and OpenTable economics.

Here is the offending page:

The problem we encountered was that non-registered users would set the radio button that said “I am a new OpenTable customer” and then fill in their email address and select a password….which sat under the “I am an OpenTable member” section. This combination caused the page to return an error message.

In response, we developed alternative treatments of our Sign-In functionality and tested them via Test & Target. The winning executions presented non-cookied users with a form tailored directly to new users, with clear visibility of a link for existing members to “Sign In”:

After the user hit the “Complete Free Registration” button, we then presented them with a popup that prompted them to register to become an OpenTable member:

These simple changes boosted our reservation success rate by 10% over the prior implementation. And a 10% improvement in the revenue stream that comprised well over half of the company’s total business due to one simple change was a monster win for the business.

Over time, the data-driven product development methodology at OpenTable matured into a highly disciplined testing regimen. Hundreds of tests have been run in the past few years. Not all were homeruns like the change above, but lots of singles and doubles supplemented the occasional home run to have a highly material impact on the business. I can’t recommend a rigorous data-driven product development process enough to managers of website businesses—it’s extremely low-hanging fruit in the pursuit of growth.

Other examples of core business optimization initiatives that helped OpenTable boost growth included:

  • Developing a new version of our enterprise software used by restaurants that improved search-to-reservation conversion by having the software better mimic the decision-making process of the person at the host stand
  • Redesigning key pages of the site to improve their efficiency, such as a complete overhaul of our search results pages (tested thoroughly through A/B testing)
  • Focusing dedicated resources on optimizing the percentage of OpenTable restaurant customers who had “make an online reservation” links on their own websites, as well as improving the visibility of those links
  • Applying concerted product and engineering efforts to boost our ranking in search engine results
  • Hiring a lot more sales people to accelerate the acquisition of restaurants using OpenTable (not product, but highly effective)

The key takeaway here is that all of the above were new, concrete initiatives that were not yet part of the company’s arsenal. Their successful deployment helped fight off the impact of gravity and led to accelerating growth for the company.

Businesses don’t grow themselves.  One of the most important jobs of a CEO is to aggressively define and pursue a growth agenda for his or her business.  Why is this important?  Growth typically improves a company’s competitive position and provides increased scale and leverage, and investors clearly value growth.

The pursuit of growth continues to be important regardless of the lifecycle of the company.  Obviously it’s critical early in a company’s life… or it won’t be a company for long.  But it continues to be important as a company develops.  Virtually all businesses, even hyper-growth ones, inevitably experience slower growth as they get larger, with their growth rates falling relentlessly back down to Earth over time.  I call this effect “gravity” and it will weigh down even the most promising of companies—unless a CEO can find a way to accelerate growth and positively change the long-term growth trajectory of the business.

The first real operating job I had was managing eBay’s U.S. business in mid-2000, which included the ebay.com website.  Virtually all the revenue—and more than all of the profits—of the eBay company came from the U.S. unit at the time, and despite the bursting of the bubble, EBAY was still trading at highly robust multiples.  So you can imagine the terror I felt when the U.S. segment failed to deliver month-over-month growth for the first time ever in my first month on the job.  The heavy weight of sky-high growth expectations was showing the first signs of a potential collision with the brutal effects of gravity.

It was clear we needed to quickly define a growth agenda that had the scale to fight gravity’s impact.  We quickly narrowed the options down to a few: spend more marketing or spend it more efficiently, innovate the product, or buy a company to help us grow.

Marketing had some leverage, but it was limited.  eBay was already one of the biggest marketers on the Internet and efforts to optimize spend were already underway.  M&A, on the other hand, felt both desperate and was controlled in a separate part of the organization.  So we quickly turned our attention to focusing on product innovation.

One of the first places we looked for growth was in buying formats.  ebay.com at the time enabled the community to buy and sell solely through online auctions.  Many in the community thought this was the magic of the site, and it clearly helped propel the company to a very strong start.  But auctions intimidated many prospective users who expressed preference for the ease and simplicity of fixed price formats.  Interestingly, our research suggested that our online auction users were biased towards men, who relished the competitive aspect of the auction.  So the first major innovation we pursued was to implement the (revolutionary!) concept of offering items for a fixed price on ebay.com, which we termed “buy-it-now”.

Buy-it-now was surprisingly controversial to many in both the eBay community and in eBay headquarters.  But we swallowed hard, took the risk and launched the feature… and it paid off big: Buy-it-now complemented auctions well, brought new users and new listings to the site, and became a very important driver of growth for many years.  These days, the buy-it-now format represents over $40 billion of annual Gross Merchandise Volume for eBay, 62% of their total.

With an initial success, we doubled down on innovation to drive growth.  We introduced stores on eBay, which dramatically increased the amount of product offered for sale on the platform.  We expanded the menu of optional features that sellers could purchase to better highlight their listings on the site.  We improved the post-transaction experience on ebay.com by significantly improving the “checkout” flow, including the eventual seamless integration of PayPal on the eBay site.  Each of these innovations supported the growth of the business and helped to keep that gravity at bay.

I came to call this process of layering in new innovations on top of the core business “adding layers to the cake”.  Much of the natural effort in the organization is spent on chasing optimization of the core business.  This makes sense, as small improvements in a big business can have a meaningful impact.  But there is huge potential leverage to adding layers of new, complementary businesses on top of the core (aka “cake”).  In the ebay.com case, buy-it-now, stores, features, checkout and PayPal integration were all new initiatives that layered on top of the core business but added something new to it.

The eBay company in its first decade is a good illustration of the impact of “layers on the cake”.  eBay U.S. was the company’s original business, and my team worked tirelessly to optimize it and add layers on top of it.  And at the company level, the eBay Inc. management team also looked to add layers.  Our first was international expansion, which started in earnest in the early 2000’s.  We followed with payments, facilitated by our acquisition of PayPal (and worth noting here that PayPal’s early growth was primarily as the payment functionality on the eBay marketplace).  Here’s what the result looked like at the company level:


Source: eBay SEC filings

eBay U.S. clearly was a fantastic business in and of itself, and it demonstrated strong, sustained growth.  At the same time, the international and payments layers grew from virtually nothing in 2000 to around 60% of the company’s revenue by 2005.  As a result, the overall company grew dramatically faster than its original core business and successfully fought off the impact of gravity for a decade.

And the market rewarded the company handsomely for this growth.  Here’s EBAY’s stock price during the period:


Source: monthly closing price for EBAY on NASDAQ

After eBay, I continued to deploy the layers-on-the-cake approach at the other Internet companies that I’ve managed.  At PayPal, the key layers we implemented there were international expansion, improving PayPal’s offerings for merchants who wanted to sell outside of the eBay platform (called “Merchant Services”), and starting to offer credit on top of our payments business.  We even trialed a text-based mobile payments product in 2006, although the market wasn’t quite ready for it at that time (I’m convinced the product’s developers and I were the only people who ever used it).

During my time at OpenTable, the key layers we introduced included building a robust set of mobile applications that expanded diner use cases, expanding internationally (again), introducing a new “Connect” product that meaningfully increased the addressable market of restaurants, and developing yield generation products that helped restaurants attract additional diners.  These initiatives helped OpenTable overcome gravity.  For example, year-over-year revenue growth rates accelerated from 23% in 2009 to 44% in 2010.

Two other illustrations of the success of this layering approach are provided by two of the most successful growth companies of the past decade: Apple and Amazon.  Steve Jobs and the Apple team relentlessly added new layers at Apple that sat on top of their original core business of computers, including the iPod, iTunes, the iPhone and the iPad.  And Amazon in recent years has innovated incredibly skillfully beyond their core physical merchandise business, adding layers such as Prime, digital goods, Amazon Web Services and the Kindle and now Fire digital devices.  These very large companies demonstrated explosive growth pretty much entirely through brilliant innovation.

Innovation clearly is THE success model on the Internet.  It explains how Google emerged as the dominant player in search, despite being relatively late to market and competing with established companies like Yahoo and Microsoft.  It explains how PayPal buried the other online payment sites that started around the same time, including billpoint.com and accept.com, despite these companies having preferred access to the massive eBay and Amazon platforms, respectively. And it explains how Facebook has come to dominate social networking, even though it was very late to market relative to Friendster and MySpace.

These winning Net companies are incredibly strong at product innovation.  They invest in it, they create cultures that support it, they prize it and they reward it.  The companies above that failed to capitalize on their early success arguably did not.  The best innovations improve and compliment the core business of a company, taking advantage of and enhancing its most valuable assets.  Diversification outside of the core business is a much more challenging strategy.  The further a company strays from its core in its innovation, the longer the odds of success.

I’m a huge believer in the potential for innovation to drive results for all companies, but particularly for technology companies.  Core to the CEO’s job is to rise above the day-to-day requirements to keep his or her vision far out on the horizon, proactively delivering new innovations today that have the impact to materially boost the long-term growth of the business in the future.

From Marc Andreessen, co-founder and general partner of Andreessen Horowitz:

Over the last several weeks, there have been erroneous reports in the press that my partner Jeff Jordan and/or I might become an operating executive of Yahoo in some capacity.

To be crystal clear, neither Jeff, nor I, nor any of our partners at Andreessen Horowitz, are in the running for, or would accept, any operating role at Yahoo, including CEO, acting CEO, chairman, or executive chairman.

Jeff and I have high regard for Yahoo, but we are fully committed to our day jobs as general partners at Andreessen Horowitz and board members of our portfolio companies.

Marc and Ben founded Andreessen Horowitz with some very explicit beliefs.  We would invest in Information Technology companies, and not in things medical, green or clean.  We would have a preference for companies with deep technical roots and innovations.  We would have one office, in Silicon Valley, and would not seek to invest in companies being incubated in places like China or India where we lacked expertise.  We would be stage-agnostic, seeking to invest in the best companies regardless of what round they were seeking.  And we would have a preference, all else equal, for companies being built in Silicon Valley.

The Silicon Valley focus is due to a couple of factors.  First, we are all believers in the power of the Silicon Valley ecosystem to incubate and grow new technology companies.  Just this week, the New York Times referred to it as “the world’s epicenter of innovation”.  We know of few places in the world that sport Silicon Valley’s combination of financial capital, intellectual capital, entrepreneurial and engineering talent and experience, and support infrastructure.  Many of the Internet’s most highly valued companies are from the Valley—Google, eBay, Yahoo, LinkedIn, Facebook and Zynga.  And the second factor is that local companies best leverage our most precious asset as investors, which is time.

Indeed, the majority of our investments have been based in Silicon Valley.  There have been exceptions—we are or have been involved in a handful of non-Valley companies such as Skype (Luxembourg), foursquare (New York) and Groupon (Chicago)—but the majority of our investments are in the Valley and all four of my Andreessen Horowitz investments (LikeALittle, Airbnb, Lookout and Pinterest) are within a 45-minute drive of each other.

With this as background, I’ve been encountering an unexpected finding as I’ve been looking at potential e-commerce investments in the U.S. (and note that I’m considering “marketplace” businesses like eBay and Airbnb as separate from e-commerce).  It strikes me that the majority of innovative new e-commerce businesses are being started outside of Silicon Valley.  There are some innovative local ones like One Kings Lane, Tiny Prints and Plum District, but the list outside of the Valley dwarfs the local list: Groupon and Trunk Club are in Chicago, ShoeDazzle and HauteLook in L.A., LivingSocial in Washington D.C., zulily in Seattle, J. Hilburn in Dallas and Hayneedle in Omaha.  And the epicenter for e-commerce innovation right now has to be New York City with companies like Birchbox, Bonobos, Diapers.com (in nearby New Jersey), Gilt Groupe, H.BLOOM, ideeli, Lot18, OpenSky, Rent the Runway and Warby Parker.  Just five months on the job and I’m already on a first-name basis with United Airlines and Virgin America crews on the SFO-JFK route.

What has driven this blizzard in e-commerce innovation in the Big Apple?  I must admit I’m not sure.  It could be because much of the nation’s fashion business is centered there, or because of Manhattan’s world-class retail infrastructure.  But it’s extremely impressive.

Given this preamble, it’s probably not a big surprise that we’re investing in an e-commerce company in New York and that company is Fab.com, a site that features daily design inspirations and sales at up to 70% off retail.  The Fab.com site was launched in June of this year and has taken off like a rocket.

We were attracted to Fab for a number of reasons:

  • The team is great.  The founder and CEO of Fab is Jason Goldberg, a talented serial entrepreneur who also founded socialmedian and Jobster.  His co-founder is Bradford Shellhammer, a fantastic merchant with a fabulous eye for design.  Their engineering function is led by Nishith and Deepa Shah, both talented technologists.
  • Their execution has been extremely impressive.  They’ve nailed the product: both the website itself and the merchandise assortment.  The site and mobile apps are beautiful and very easy to use, and Bradford’s merchandise team constantly finds beautiful, inspiring goods to offer to consumers, typically at attractive values.  They’ve leveraged social extremely effectively, sourcing over half of their users, and they leverage data as effectively as any company I’ve ever worked with—startup or not.
  • They are playing in a big market.  The umbrella of “design” allows them to offer merchandise across a wide variety of categories (such as home products, jewelry, artwork, apparel, workplace items, toys and outdoor products) and price points.  The Fab merchants scour the world to source product from a long tail of great designers who often struggle to gain national distribution, and designers love that Fab.com sales are profitable for them.
  • Their early traction is simply phenomenal.  Jason is extremely transparent with Fab.com’s business metrics and recently revealed that the company is averaging $200,000 in sales a day.  Not bad for a company that made their first sale in June.
  • They have a very big vision for where they want to take the business.

I’ve rapidly become a big Fab.com consumer, as the UPS man and my spouse can attest.  It’s as close to addicting as anything I’ve ever experienced in e-commerce.

Fab.com is an example of a new wave of highly innovative e-commerce companies; indeed, I believe there has been more e-commerce innovation in the past few years than at any time since the beginning of the Internet, and at Andreessen Horowitz, we need to update our assumption of Valley centricity, at least when it comes to e-commerce.  Fab.com joins my partner John O’Farrell’s investment in L.A.-based ShoeDazzle as examples in our portfolio of this trend.

Jason signs off on much of his correspondence with the phrase “smile, you’re designed to”.  We’re smiling from ear-to-ear at the prospect of partnering with Jason, Bradford and the Fab team to build a big, important e-commerce company.

OK, I’m going to date myself here.

I graduated from college in the early 1980s and entered the professional workforce. Most of you wouldn’t recognize the office I worked in: phones sat on desks, were plugged into walls and were the only way you could communicate with workers not in the office. “Spreadsheets” were largely done by hand on big sheets of paper, aided by desktop calculating machines. Our department had one personal computer that had to be shared. It sat on a desk and wasn’t connected to anything but the power supply and a printer. “Portable” computers emerged in the middle of the decade. The first one I saw was the size of a suitcase (it actually had wheels) and people said it was “luggable.”

During the 1990s, I found myself working at The Walt Disney Company in southern California. Computers were now on every desktop, becoming more powerful, and their uses were expanding. My future partner Marc Andreessen was up north leading the development of the first mass market browser. All of a sudden, email and Internet access stormed the workplace. I also distinctly remember the first time I encountered a “cellular phone”—it was the size of a lunchbox and couldn’t legitimately be characterized as “mobile”. Personal digital assistants (aka PDA) came onto the scene later in the decade, but they lacked connectivity and typically had to be synched by actually tethering the device to your computer.

At the new millennium, I was responsible for managing ebay.com. The Internet revolution was on and online commerce was simply exploding. Computing was undergoing a revolution as well—a mobile revolution. Laptops started replacing desktops. Cellular phones and PDAs essentially merged and the smartphone was born. I used to wear out BlackBerrys by answering much of my email on the go (I frequently used the Berry while on the elliptical machine in the gym, an acquired skill). Then Apple debuted the iPhone in 2007 with its touch screen, robust mobile browser, and, soon thereafter, third-party applications. Google quickly followed with Android.

Today, this mobile revolution is in full swing and is changing computing dramatically. For the first time, smartphone shipments exceeded PC shipments at the end of 2010. The iPad tablet is Apple’s fastest-growing new product ever and everyone else is scrambling to jump on the tablet bandwagon. IDC forecasts that more people will access the Internet via mobile devices than PCs by 2015. Personally, smartphones and tablets have already acquired the lion’s share of my own computing time and the PC is now relegated primarily to power email (and occasional blog composition).

Mobile applications are also proliferating. Internet incumbents such as eBay, Amazon, Yelp and OpenTable (where I’m executive chairman) are bringing their services to mobile devices with great success. New companies are also building services that subsist on mobile-specific capabilities—think foursquare, Bump and Uber—and many are investing and innovating with the goal of turning mobile devices into wallets, such as Square and PayPal.

Unfortunately, when there’s progress, there’s also peril. Wherever e-commerce happens, bad guys descend to try to steal some of the money that is being exchanged. I encountered this at both eBay and PayPal, where much of my time was spent fighting off relentlessly escalating threats from what largely was organized crime. Today, that’s starting to happen on mobile devices. There were more mobile security threats identified in July 2011 than in all of 2010, and it’s estimated that one in three smartphone users will encounter an unsafe website this year on their phone. This trend will only worsen as mobile adoption increases and mobile commerce continues to expand.

With this context, Andreessen Horowitz is delighted to announce our newest investment in Lookout Mobile Security. Lookout is pioneering a new approach to mobile security and wants to give people the confidence to do more with their phones by providing protection against mobile threats. They’ve built a number of highly innovative products:

  • The Lookout app protects against digital threats like malware, spyware and unsafe websites. It also backs up critical personal data (like contacts or photos) and can find a lost or stolen phone. Unlike many security apps, it’s both easy to use and optimizes device performance and battery life.
  • On the backend, Lookout’s Mobile Threat Network combines algorithmic analysis with a cloud-based architecture to rapidly identify new mobile security threats. They have been the first service to detect and protect against many major threats, often within minutes of the appearance of threat in app stores and before the threat reaches a user’s phone.
  • Unlike traditional security vendors, Lookout, through the Lookout API, is sharing its incredible dataset of information with the mobile community to keep people safe. The Lookout API automatically provides threat data to partners such as Verizon so that they can ensure that their app stores are safe.

Together, these products have resulted in Lookout assuming a global leadership position in mobile security. The company currently protects over 12 million users in 170 countries and they are adding an additional 1 million users per month. They are the top-rated and -ranked security app in the Android Market, and PC World named them the Top Product of 2010. They have also established partnerships with a number of leading carriers in the U.S. including T-Mobile, Sprint and Verizon.

The Lookout founding team includes talented hackers (in the best sense of the word): John Hering, Kevin Mahaffey and James Burgess. The trio has deep technical roots and strong DNA in the security world. While students at the University of Southern California, they found a vulnerability in mobile device Bluetooth connections, but they couldn’t get device manufacturers to take the vulnerability seriously. Determined to make their point and drive awareness of the vulnerability, the trio created a contraption called the “BlueSniper rifle” and demonstrated it with great success at the DefCon security conference. They are young, innovative and relentless—the perfect backgrounds for the folks you’d trust to keep your mobile devices safe.

As CEO of Lookout, John is a very impressive entrepreneur—one with a compelling vision, passion, talent and commitment (read more from John here). He’s rapidly assembling an excellent executive team and a strong board. We are honored he chose to partner with Andreessen Horowitz and I very much look forward to working closely with him as an investor and board member.

Andreessen Horowitz led the $40 million round, joined by current investors Khosla Ventures, Accel Partners and Index Partners. The proceeds will be used to broaden the company’s product offerings, fuel global expansion and build a world-class team.

Download Lookout! You’ll be glad you did.

Talk about a business with humble roots. Brian Chesky and Joe Gebbia met at the Rhode Island School of Design and became roommates in San Francisco in 2007. A prominent design conference was coming to town and the nearby hotels were sold out. Joe and Brian thought it might be both fun and lucrative to rent out space in their apartment to conference guests looking for lodging, but alas they lacked the requisite beds. Turns out that Joe had a few airbeds in the closet. They threw in a morning meal and “airbedandbreakfast” was born. Three lucky conference attendees enjoyed good accommodations, food and hospitality while Joe and Brian enjoyed the company of their guests and some very welcome income.

Joe and Brian resolved to make a run at transforming this experience into a business.  They were joined by a third co-founder, Nathan Blecharczyk, who brought programming expertise.  The name was shortened to “Airbnb” and they launched their website in 2009.

The Airbnb service quickly struck an extremely powerful chord with consumers. Growth has been flat-out explosive, with over two million room nights already booked. The site now features spaces in 186 countries and over 16,000 cities around the world. Hosts can earn substantial sums of money—one has even used Airbnb earnings to pay off his mortgage—and their community of users is passionate about the service, enjoying the social aspects of Airbnb travel.

The community has substantially expanded the type of spaces offered on the Airbnb platform, moving well beyond a room in a house or apartment. You can now use Airbnb to rent apartments, homes, cabins, tree houses, boats, parking spaces, castles, sublets… and even a country (for the bargain sum of $70,000 per night, you can rent out the country of Liechtenstein like rapper Snoop Dog).

I first came across Airbnb in March, when Brian presented the business at an investor conference I was attending. For me, it was a true déjà vu experience. I joined eBay in 1999, early in its life, and had the privilege of witnessing and contributing to the development of one of the most iconic e-commerce businesses. Airbnb reminds me more of eBay in its early days than any other business I have ever encountered. Both are:

  • Marketplace models, connecting buyers and sellers
  • Community-driven, populated with passionate users who evangelize the service
  • Providing economic opportunity and empowerment to their sellers/hosts, enabling them to earn meaningful income
  • Platforms upon which their community of users continually expands into new verticals
  • Helping to make inefficient commerce efficient

Not coincidentally, Brian, Joe and Nate also see these same similarities. They believe Airbnb is to spaces what eBay is to products.

We have been extremely impressed by the execution of Brian, Joe, Nate and the rest of the Airbnb team.  The website is clean and very intuitive—not surprising, I guess, when two of the founders are designers.  They have built and motivated a vibrant community of evangelist users.  They are extremely scrappy marketers, and have executed brilliantly to acquire hosts/properties and renters.  And they have been ably managing the operations amidst simply explosive growth.

And while the company has accomplished a ton in just a couple of years, we believe that they’re just scratching the surface of their potential. They have opportunities to go much deeper in their current categories, broaden into new categories of spaces, and build out their global footprint.  They are truly pioneering a new marketplace, where access to spaces is more valuable than ownership.

Andreessen Horowitz led Airbnb’s latest financing round, investing $60 million of the total raise of $112 million.  We’re thrilled to be partnering with the Airbnb team, and look forward to supporting them in building an iconic e-commerce franchise!