Tuesday, January 31, 2012

Top three reasons NOT to do a local + online startup (and what to do instead)

Disclaimer: Entrepreneurship is all about passion: if you've decided that selling to local SMBs is your life's work, I celebrate your choice. This post is for all the entrepreneurs who are currently evaluating local / hyperlocal business ideas, but might be just as happy doing something else.

Hi, my name's Chris, and I'm an online-local-a-holic.

I spent four years of my life (and several million dollars of Brad Feld's money -- sorry Brad) trying to build a sustainable business in online-to-local customer engagement at Judy's Book.

The iPhone didn't yet exist, but even in 2004 we understood the power of user-generated content and social curation (we actually trademarked the term "Social Search" before it became a commonplace). We had more than enough success on the content + distribution side of the business to feel like we were making a dent, but after years of trying and dozens of experiments we just couldn't see how to produce margin on the business side.

We made plenty of stupid mistakes at Judy's Book (if you want the excruciating details I'm happy to share), but we also learned some very hard lessons about the self-limiting mechanics of the local opportunity, in particular how resistant it was (and still is) to many of the best and most powerful aspects of the web.

Since then I've seen dozens of local + online deals -- they come up often in the usual flow of Founders Co-op / TechStars Seattle / PIE PDX business, while others follow the Judy's Book crumbtrail and reach out specifically to ask about our lessons learned.

It  feels like I've been telling the story more often lately, so I figured it was time to write it down again...

There are lots of big, hairy problems in local -- and with full credit given to the disruptive power of smartphones -- most of those problems are just as intractable now as they were back in 2004. 

One more time, for the record, the top three reasons NOT to do an online-to-local startup are:


1. There's no money in it

This is an exaggeration, but not a big one. The fundamental economic problem with local / SMB-oriented businesses is the structural mismatch between the expected lifetime value of a paying customer vs. the cost to acquire that customer.

Someday, most small business owners will be online natives, deeply comfortable with web-based software, social platforms and mobile devices. Until that time, selling to SMBs will require lots of handholding, education and convincing that this whole internet thing isn't just a fad (seriously).

This kind of "education selling" is brutally expensive and time-consuming, especially when you're a startup with limited resources and zero brand recognition. Despite years of effort and billions of dollars spent by big brands like Google, Microsoft and IAC, there's no convincing evidence that the great mass of local SMBs are prepared to embrace the level of self-service required to make selling to them cost-effective.

Making things worse, local SMBs are just like web startups -- they have a nasty habit of going out of business. The successful ones tend to grow into big businesses (think Starbucks and McDonalds); the passionate, well-run, indie-on-purpose ones make just enough to get by, and the vast majority fail, making way for the next wave of inexperienced entrepreneurs with a dream of running their own store.

Combine expensive, high-touch selling, small budgets and high churn rates, and you have a perfect recipe for persistent negative margins. 

Don't believe me? Take a look at Yelp's S-1 (and this great analysis by VentureBeat).

Yelp is arguably the "winner" of the local online category -- with the best product, the best brand and the strongest backers. After eight years of operation the company generates unspectacular revenue ($58MM for the first 9 months of 2011), burns 2/3 of revenue on sales + marketing, and has never even come close to operating profitably.

Worst of all, the company generates an average of just $828 from each local advertiser, barely enough to cover the hand-to-hand combat required to sell, close and support them. Add in normal churn and the structural pressure of persistently high SMB failure rates and lifetime value quickly turns negative.

If Yelp's business is what "winning" looks like in local, I'm not sure that word means what I think it does.


2. It doesn't scale

One of the reasons entrepreneurs and investors love web-based businesses is their inherent scalability: put a great product on the web and -- at least in theory -- any one of the more than 2 billion connected humans around the world can use it, and some of them might even pay you for the privilege.

Add a local constraint to your online business all that scalable goodness goes away.

To their credit, Yelp understood this from the beginning -- they took the slow and steady approach, focused exclusively on restaurants and bars in San Fransicsco to start, nailed that experience, and then added other cities slowly and selectively. (It didn't make them any more profitable, but at least they did local right).

At Judy's Book we let our impatience get the best of us, turning on many cities and categories simultaneously in the hope of accelerating growth and discovering pockets of demand organically.

In doing so, we deceived ourselves about reaching product-market fit -- even as topline growth in customers and reviews began to accelerate, we didn't have the brand recognition, localized traffic or customer engagement in any one market to deliver real value to advertisers.

In local, it doesn't matter how many uniques, views or registered customers you have across your entire product. Unless you can deliver new customers with pinpoint accuracy -- down to the category + neighborhood level -- you don't have a business. 

The only way to build that level of location-bounded customer engagement is by doing it the hard way, with high-touch experiences that feel local and personal, even when they're powered by a common platform. It can be rewarding and fun if you like that sort of thing, but it absolutely crushes the scaling potential that makes web-based business so great.


3. It's too obvious

This is less an objection to local than a general indictment of obviousness in startup ideas, but I tend to rank local / SMB startups right up there with consumer music apps in the "does the world really need another one of these?" category.

I hit this topic harder not long after we sold Judy's Book, and my views haven't really changed much since then:
"Starting a local reviews site is the online entrepreneur's equivalent to the fiction writer's maxim of "write what you know." The internal monologue goes something like this: "I love to eat at great new restaurants with my foodie friends. Existing review sites are mass market mediocrities that sing the praises of T.G.I. Fridays. If only there were a site that spoke to my personal tastes and values. If I build it others will come."
As I've said (often) before, we are now in an era of perfect competition for software startups. All the obvious ideas have been done -- sometimes well, but never without dozens of also-rans cluttering up the landscape and confusing consumers and potential customers alike.

Viewed from the top down -- numbers of SMBs, total SMB spend, profits of incumbent players (e.g., yellow pages / local media) -- local looks like a compelling opportunity for technology-powered disruption. But when you start to unpack local from the bottom up, it doesn't take long to appreciate that death by a thousand cuts is the fate that awaits you.


OK, local sucks. What SHOULD I build?

If you want to build a business that -- unlike local -- takes full advantage of all the goodness that a globally connected society, free software tools and pay-as-you-go cloud infrastructure make possible, start here:

Take the time to really dig into a hard and non-obvious problem that actually needs solving -- ideally one with a lot of money attached to it.

A well-designed software business takes away pain for money, with accelerating margins at scale. 

There are literally millions of business opportunities that meet these simple criteria better than the best local business I've ever seen.

Startups are hard enough -- do yourself a favor and don't stack the deck against yourself before you've even begun.