How Shapeways landed a landmark $30m financing round

The Economics of Freemium games

Economics is occasionally derided as a phony science. Frankly I struggled with it school and university so to me this description really resonates. How can the graphs and formulae in the textbooks ever really capture the behavior of complex organizations and impulsive consumers?

However, exposure over the last few years — first to the social gaming phenomenon and now to the exploding mobile-gaming industry has made me realize that maybe those dusty textbooks might contain some valid insights.

If you study the Android and iOS app-stores a few things become apparent. Games rather than productivity or other apps dominate the free, paid and top-grossing charts. This is entirely consistent with the behavior you will observe on any bus or train. Playing games on the latest generation of phones and tablets is the dominant use case, accounting for approximately 60% of all hours spent on these devices.

A second observation is that a disproportionate share of the top-performing games are developed by European rather than U.S. companies. That is an interesting topic in itself and I may return to that in another post. Lastly and perhaps counter-intuitively, the games which consistently make the most revenue are all freemium. That is, they have no upfront download fee, but various optional in-game purchase options.

This post first appeared on the Wall Street Journal’s Accelerators section - http://blogs.wsj.com/accelerators/2013/03/03/the-economics-of-freemium/

Why has freemium become the winning business model? To understand, we need to rewind a few years to when the games industry was dominated by high-priced content distributed on DVDs through retail channels. In this world, consumers would read reviews and then decide which games to invest their money and time in, much like how they would decide which film to watch.

Subsequently, some consumers are delighted by the game and perhaps with hindsight would have been willing to pay much more than the box price. Others would be annoyed and resent having paid so much. An important third group, many of whom might have been prepared to something but not the full price, would not engage with the game at all.

In economic terms, the game company only exploits a portion of the overall demand curve for their product. Also most consumers either pay too little or too much based on their own perception of the product.

Freemium games by contrast are an almost unique case where companies can perfectly price-discriminate down to the level of the individual consumer. Customers are not confronted with any upfront price barrier. On mobile devices, downloading and trying a game for the first time can now be an almost frictionless process.

Afterwards, the games company can extract an increasing amount of revenue from customers, according to each customer’s specific willingness to pay. Even those who choose not to pay anything play a crucial role in the success of a title by helping to spread awareness of the game and boost its ranking and visibility in the app stores.

Does this model exploit consumers? Some argue that it does, but the more compelling arguments support the opposite view. By offering many consumers a free gaming experience, a much broader audience who might never pay for a game get to experience the product. Every paying player also knows precisely what utility is provided by paying, and can make a much more informed decision about whether and how much to spend. Since spend perfectly matches the derived utility, both consumer and company are happy.

Beyond just allowing consumers to set the price, the best games also offer consumers the ability to craft the game around their own preferences. A whole new vocabulary has emerged to describe the different kinds of virtual products and services which game developers deploy to make their games appeal to different segments. Decorative objects appeal to those who take pride in how their avatar or game environment looks.

Purchasing more energy to play further in a game appeals to those who are time-constrained and unable to wait for their energy to refill. For those with more time to play and a competitive instinct, a greater portion of spending may be invested in performance enhancers. This category itself subdivides into durable items which persist, such as weapons or buildings, and potions which give a short-lived performance advantage at some vital stage in a game.

So freemium games represent an economics experiment in its purest form. Companies allow consumers to set the price and even determine the precise characteristics of the product. The amount that consumers pay precisely matches the utility they derive. By achieving this perfect economic balance, freemium mobile games are transforming the entertainment landscape and proving that perhaps occasionally the field of economics does have some helpful insights.

Dating Advice for Investors and Entrepreneurs

The process of fundraising is not just about getting an equity investment to launch or grow your business. It is also about finding an investor who will sit alongside founders in the cap table and influence strategy, tactics and business culture.

The impressions that develope during the pitch, diligence and the closing process set the tone for the subsequent relationship.

A common misconception is that investors have the upper hand in these discussions, and that the onus is on the entrepreneur to prove themselves and their businesses worthy of investment. In practice, this has not been the case for a long time. Over the past few years, the proliferation of seed investors and other sources of funding has established a level playing field between investors and entrepreneurs.

Certainly, in almost all of the investments my firm has made recently, the entrepreneurs have had other offers of investment, and we have had to sell hard to make sure they take our money. In discussing this topic, I have outlined some tips and ideas not only for entrepreneurs, but also for investors on how to create a positive and productive dynamic during the fundraising process.

Entrepreneurs: Be Confident, Well-Rehearsed but Open to Advice. 

For entrepreneurs, it is important to be confident, and to establish in the mind of the investor that whether or not he or she chooses to invest, the business will be moving forwards with other sources of funding, or on its own. The worst impression to create is that nothing will happen unless — and until — funds are committed. Investors love to jump aboard a moving train rather than to pile heaps of coal into the furnace before discovering whether the train is functioning or not. I often say that the best indicator of how much an entrepreneur can achieve post-fundraising is how much they have been able to achieve with no capital. Many crucial aspects of launching a business, such as market research, speaking to potential customers, identifying co-founders and employees and creating a prototype of a product can all be done with little or no investment. An entrepreneur who has done all these and can present with passion will always be preferred to one who has just sketched out a business plan but made little substantive progress besides.

Investors want to see entrepreneurs who are confident but also well-prepared and highly knowledgeable about their business and industry. Being confident without being prepared is the worst combination from an investor’s perspective. So while a convincing elevator pitch can open doors and lead to future meetings, the subsequent discussions allow investors to test the entrepreneur’s passion, knowledge and depth of insight. A strong vision for an early-stage business is its vital flexibility and openness. To experiment is also important, since the first product launched is rarely the product around which the business is built.

Investors like to feel that entrepreneurs will listen to ideas and occasionally take advice. Almost always, the entrepreneurs have the best ideas, and smart investors typically realize this and want to capitalize on it. However, an entrepreneur who is overconfident and completely closed to suggestion won’t attract the best investors or valuations.

Investors: Sell Hard, But Be Honest and Direct. 

For an investor in a competitive deal, there are lots of easy ways they can find themselves ejected from a syndicate. Firstly entrepreneurs want shareholders who will act as supporters and show a level of trust rather than trying to exert excessive control. In due diligence, there is always a delicate balance to be struck between asking for sufficient information to make an informed investment decision and asking for so much information that the entrepreneur feels their precious time is being wasted.

A good signal to an entrepreneur is when the investors allocate more time during fundraising to identifying areas of opportunity and upside rather than trying to eliminate all perceived risks.

Entrepreneurs ultimately want to work with investors who are willing to share risks, rather than arbitrageurs who seek to eliminate all risk before they invest.

Entrepreneurs proactively seek out investors who can add value with recruiting, business development, marketing and ultimately an exit strategy. Most venture capitalists have a well-rehearsed pitch concerning these credentials, but often this is a pitch and little more. Investors need to be able to support their claims and should expect entrepreneurs to do their own due diligence and reference-checking before they accept a new investor.

The relationship between an investor and the entrepreneur must be based on trust. All too often I have seen investors try to outsmart an entrepreneur during fundraising by introducing complex investment structures to befuddle him or her and give the investor an advantaged position once the investment has closed. This is always a misguided strategy, investment terms should be simple, transparent and well understood by all sides.

Intensive negotiation over convoluted investment structures doesn’t create value — entrepreneurs always realize this, but somehow investors often don’t grasp this point. Post-investment everyone needs to be on the same team. Open, direct and honest negotiation is the best way to reach this point.

This Article first appeared in the WSJ - http://blogs.wsj.com/accelerators/2013/02/11/dating-advice-for-investors-and-entrepreneurs/

Great VCs Come From a Range of Backgrounds

The most successful venture-backed companies are those with great entrepreneurs, disrupting a market at just the right time. Clearly the capital and claimed expertise of VCs do not on their own create a winning company.

The entrepreneur and founding team are the most critical building blocks. After all, entrepreneurs can be successful without venture capitalists, but the reverse is obviously not possible. Venture capital amplifies the success of the best startup companies, and also in marginal cases, the capital and support of a good venture-capital firm can make the difference between a positive or negative outcome for all concerned.

Not a Dying Species

Over the past 10 years, there have been some fundamental trends which have had a big impact both on the venture-capital industry itself and the ability of venture capitalists to support entrepreneurs. Firstly, the capital required to launch and grow startups has dramatically fallen during this time, driven by the proliferation of open-source software and the emergence of cloud-computing platforms and new marketing channels like Google, Facebook and the Apple and Android ecosystems. Now startups often can launch and begin to scale their businesses with a fraction of the capital that might have been needed in the past. A more recent trend is the widely discussed phenomenon of angel investing and the arrival of crowdfunding platforms such as Kickstarter and AngelList.

Many commentators have therefore declared that venture capital will become redundant. The argument goes: “Why would you raise lots of venture capital when so little is needed to test an idea and this quantum can be readily sourced from angel investors or Kickstarter?”

While this is a good narrative supported by valid arguments, it ignores a key point. While the costs of launching a startup may not require venture-capital funding, this rule also applies to all a company’s current and future competitors. Very few startups can rely on a unique technological advantage to protect their position. The key competitive defenses that startups must erect are the network effects generated by reaching a certain scale and building a great brand that resonates with customers. To achieve both of these before your competitors do, rapid scaling is required. This is the true role of venture capital in the modern startup ecosystem. The venture-capital industry no longer dictates which ideas and businesses get backed at startup stage, but it does and will continue to play a pivotal role in growing great technology-based businesses.

Diverse Backgrounds

Considering the changing nature of the investing landscape, what credentials, experiences and skills must a venture capitalist now possess to succeed? Should all venture capitalists ideally be former entrepreneurs? Possessing insight and empathy for founders as they cope with the challenges of growing a startup can be a winning calling card for a venture capitalist.

Many entrepreneurs proactively seek out entrepreneurs-turned-VCs for precisely this reason, and many venture-capital partnerships rightly place great emphasis on their own entrepreneurial credentials. This is definitely part of the formula for what makes a good venture capitalist. Successful venture capitalists come from diverse backgrounds — journalism, banking, consulting, large tech companies, even politics.

Transparency, respect and similar goals are each crucial for an entrepreneur and a venture capitalist to build a constructive relationship. In some of the most productive relationships, the entrepreneur supplies a depth of knowledge of a given industry and the venture capitalist brings a breadth of insight obtained from having worked with many different companies. At our firm, we expect entrepreneurs to have excellent knowledge of the specific industry they operate in, either through past experience or copious amounts of research that they have undertaken. We therefore generally trust them to have the best ideas and understanding of how precisely to craft their product or service to attack a particular industry.

The venture capitalist, by contrast should bring a range of insights and connections from the different companies and industries to which they have been exposed. Also a broader set of experiences in international expansion, channel and reseller partnerships, M&A, IPO, compensation and HR expertise can be provided by an experienced venture capitalist.

The reality is that no individual venture capitalist will bring this whole spectrum of skills and knowledge. Venture capital is a team game, and the best venture-capital partnerships provide support and a range of services to their companies. A venture capital A-team would certainly comprise one or two successful entrepreneurs, but there should also be room in the van for people who bring skills and insights from outside the startup ecosystem.

This article also appeared in the Wall Street Journal online and in print. http://blogs.wsj.com/accelerators/2013/01/23/as-the-industry-changes-venture-capitalists-must-stay-current/