February 28, 2010

Going into space - What you can do If you really put your mind to it.

Today I went to a rocket testfiring of what will probably be the first Danish launch of a human being into space. You could hear the roar of the rocket for miles as it went off strapped to a huge concrete block. That's pretty big. The bigger thing is that it's all done by a private venture. And the really amazing thing is that it's done by two ordinary guys who just decided that this is what they're going to do, and not care what anyone else thinks. No rich dad, no venture funding, no prerequisites whatsoever. They just decided to do it.

Getting a human into space isn't easy, far from it. NASA spends billions doing it, and they still don't get it right every time. They've spent the last 50 years perfecting rockets, heat shields, trajectories, recovery, telemetry, fuels, computers, communication and a host of other technologies. The money has been spent building knowledge and designing better materials, which enter the public domain and quickly become available in the marketplace. This means that you don't have to start from scratch. You're standing on the shoulders of giants. You can dig into the costly research and see which mistakes have been made and what insights have been gained. You can go out and buy advanced ceramic materials and aerogel. You can do this because the research has already been done, and the costs have already been incurred. Spaceage materials are now cheap and common.

Burt Rutan was standing on the shoulders of giants when he won the Ansari X-price by launching Spaceship one into space twice in a two week period. A long lasting government monopoly had been broken, and small nimble companies started appearing out of the woodwork. Space tourism is being talked about, and will probably be a reality in the near future. Continued development and progress in the arena is the only thing that has made this possible. Burt Rutan wouldn't stand a chance with the technology available to NASA in the 60's, but luckily they spent billions so that he could undertake his amazing journey using the technology and materials that have been perfected over the last 50 years.

And now Copenhagen Suborbitals is pushing the envelope even further. They're basically the two proverbial guys in a garage building the future. They've rented some cheap land in an old shipyard and spend night and day welding and calculating. They're financing this by getting sponsors and charging the public $40 to see the rocket tests they do. They're not only guys in a garage, they're guys in a garage that wil send a human in to space without any funding except sponsors and admission fees. They have currently raised less than $20.000 and materials (liquid oxygen, stainells steel flanges etc.) and are doing fine.

I know one of the guys, Peter Madsen, because before he started building rockets he built the worlds largest homemade submarine. He's the kind of guy that just doesn't take no for an answer. He'll keep on going until he succeeds or dies. There's nothing in between. This attitude combined with the available technology gives me great hope that him and Kristian von Bengtson will succeed. The combination of great personal drive and cheap available technology is very powerful. With it you can do almost anything you want. Like building your own rocket to shoot you into space.

Building a startup is similar - it's never been easier due to cheap available technology. It isn't even rocket science.

Oh, and this is one of the rare cases where the "Launch early and launch often" mantra of many startups doesn't apply


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August 06, 2009

Dreamers and doers


Kevin Rose showing the dreamers how to run a company





Avoid the dreamers.


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July 22, 2009

Economists don't know what they're talking about.

Classical macroeconomic models are in trouble. They have difficulty predicting even the most basic things. As is apparent to anyone who bothers to go back and check the predictions and forecasts that are made by economists they are mostly just random numbers. Not because of bad faith, but because of bad models.

In the current economic crisis one major school of economists, the Keynesians, propose massive government spending to stimulate the economy while another major school of economics, the Austrian School, warns that this will inevitably trigger high inflation and should be avoided at all costs. Both schools of thought have an impressive amount of Nobel laureates backing up their respective views, and are well respected for their views and models of the world. So should the government spend massively to regain its footing? Nobody knows.

In an economic stagmire such as the one we are experiencing now economists look back at similar scenarios of the past to get an idea of how to move forward . What triggered the great depression that started in 1929 and didn't end until the second world war? The keynesians believe that underconsumption and overinvestment caused it. The Austrian school of economics believe it was caused by the fall of money supply. Or as the Wikipedia article on the causes of the great depression states: "historians lack consensus in describing the causal relationship between various events and the role of government economic policy in causing the Depression." In other words: Nobody knows.

What about housing prices? Since they are at the heart of the crisis there's a keen interest in knowing whether they have reached the bottom or are still sliding. New numbers have just come out telling us that U.S. house prices rose 0.9% from April to May on a seasonally adjusted basis. Most experts had expected them to fall by 0,2%. Is this a green shot that will soon turn brown, or is it the start of a recovery? Nobody knows.

These examples are in no way unique. The June edition of the 1993 OECD Economic Outlook may have the best example of just how useless our macroeconomic models really are. The official GDP growth and inflation forecasts of the G7 countries from 1987 -92 were compared with a model that simply predicted that next year will be the exact same as this year. And they were equally good. The inflation forecast was even a little bit better. In other words, guessing that next years inflation will be the same as this years is a good a guess as the one government econmists spend vast resources deriving from complicated models. And these forecasts are the ones we base our econnomic policy on. And they're random. Nobody knows.

Why are we still using these models? Probably a combination of several reasons. Tradition is one. These models and their assumptions are the ones we have always used. Career economics is another. It is not unknown in science that the practitioners tend to stick to their models, since they have been using them for all of their careers. Old habits die hard, and it's hard to teach an old dog new tricks. Thirdly it's a question of mathematics. Most models assume that all human beings act in a rational way which anyone can tell you is not true. As a matter of fact a famous study has shown that the only two groups of people that act as economically rational beings are economists and psychopaths. Most models also assume that people don't interact. And that they all have perfect information about the market. Which is obviously not true. But these things are hard to model mathematically, so most economists just stick to their guns. The famous physicist Max Planck once remarked that in early life he had thought of studying economics, but had found it too difficult.

Where do we go? The problems of classical economics run deep. Macroeconomists can't agree on the most fundamental of things, give random predictions and advice, and base their models on assumptions that bear no resemblance to real life scenarios. It's not just the little things that don't work, it's the whole thing. What is needed is a fundamentally new way of thinking. People aren't rational. They don't have perfect information about the market. Supply doesn't always follow demand. We need a whole new framework. Behavioral economics, which Vernon L. Smith and Daniel Kahneman won the nobel prize for studying might be one way. Complexity and Chaos theory might be another.

Will we ever fully understand macro economy?

I don't know, but I do know one thing.

Right now the emperor has no clothes on.


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July 12, 2009

A case for online office apps

A friend just sent me his thesis on Business angel networks in Denmark as a word document. I promised to read it through and comment on it before he turns it in some time next week. I've spent the last two hours trying to open the damn thing.

The core of the problem is apparently that the document is created in word 2008 and my version of word is 2003. So I get an error message, and a prompt with a Microsoft URL where I can go and download a word converter. Fine, no problem. I try to download the 30mb. program using firefox, but it continually hangs around halfway through the download. After around ten tries I give up, and try an office converter program that is linked from the Microsoft download page. After a few false starts I manage to download the program. When I run it I find out that it doesn't work with my version of Word for some reason. Back to square one. Maybe the download will work better with Internet explorer, after all Microsoft program have been known to be hostile towards Firefox. No. "The connection was reset".

In the end I had to ask my friend to resend the document saved as a word 2003 document.

If he had used an online office suite such as Google docs or Zoho I wouldn't have had these problems. Microsoft should really be better at covering one of the areas where they are most vulnerable. Sharing documents in online apps is as simple as sending a link, not a 2 hour ordeal that ends up in failure.


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July 08, 2009

Why Google is making an operating system

Today Google announced that they are launching an operating system called Chrome OS. This is a strategically very smart move.

Google makes money off the web, their primary source of revenue is adsense which brings in billions of dollars a year. They are quickly diversifying their offerings with google apps, gmail, analytics and a host of other applications. All of them webbased. They are an Internet company by heart: This is where their soul lies, and this is what they do best. Their back-end technology is unsurpassed and their brand is phenomenal. Their future and financial success depends on the Internet. Or more precisely it depends on having as many people and corporations as possible moving most of their information and work online. Preferably to one of Google's offerings.

There are two gatekeeper products between the user and Googles products: The browser and the OS. A user needs an OS and a browser to reach Google's products, and whoever controls these can put up roadblocks between the user and Google. I'm talking about Microsoft here of course. And since many of their products compete with Google, Office being the prime example, they have have all the incentive in the world to make the users way through the OS and browser as hard a s possible before they can reach Googles products. It's a good strategic decision, Office is a major cash cow and accounts for a large part of Microsofts revenue. It would be stupid to make it easier to use a competitors products if you can do something about it. Which Microsoft can because they are the gatekeepers.

Google knows this, and are trying hard to change the status quo. That's why they have long supported the Mozilla foundation who make the Firefox browser. It's also why they launched their own browser last year. Microsofts Internet explorer has always been buggy, and not quite up to date. The newest technology often isn't available in explorer. This isn't because Microsoft engineers are stupid, it's because Microsoft management is good at strategy. They want people to use the Internet for browsing news and finding information, not to start undermining the goldmine that is office. And you need a state of the art browser to use the heavy javascript that makes online productivity apps possible. When Google launched a browser it was a jab at the gatekeepers. It was much faster and more responsive than Explorer, and the javascript engine blew them out of the water. This put Microsoft in a strategically bad position, they didn't want to make the browser so good that online apps could eat away at their core business, but if they didn't follow suit they would start losing marketshare quickly. Damned if you do, damned if you don't. Note that Google's browser doesn't need to have a large marketshare, indeed that's not the goal. The goal is to show the world what can be done in a browser, and thereby forcing Microsoft to innovate. And it worked: The newer versions of explorer are faster and have particularly gotten better at executing javascript, the backbone of online apps. Google won the browser war, with the help of Mozilla. The important point here is that Google doesn't care what browser you use. They don't make money on browsers, they make money on online offerings and apps so all they care about is that your browser is fast and supports the newest technologies.

Now they are launching an operating system, and attacking the last gatekeeper technology between the enduser and their offerings. Strategically the situation is exactly the same as the browser war, Google doesn't care if you use their OS. All they care about is that you can get to their products quickly, and that you start moving your data onto the web instead of keeping it on your own harddrive. And the way to do this is to launch an operating system that shows how easy it is to use the Internet for almost anything. That's why they have been boasting about ridiculously low startup times. Turn on your computer and 10 seconds later you'll be at google.com. And they'll use the OS to show how little you actually need to have on your computer, how few programs you need installed, and how much easier it is if you find your information with Google, use Google docs for your work, share your family pictures with picassa, and check your website stats with Google analytics.

Microsoft will have to adapt, and follow along. If they want to keep their marketshare that is. Of course they'll be destroying their core business in the process. Damned if you do, damned if you don't.

This one will be hard for Microsoft to counter.


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June 10, 2009

Worst case scenario

When you start a company it's common to write out a best, expected and worst case scenario analysis to see how many yachts you'll be able to buy if all goes well. And how bad it'll be if nothing goes according to plan. The worst case analysis is often just the best case with little or no sales. "The worst that could ever happen is that we create a product, and not a lot of people will buy it" This is often wildly optimisitc.





Next I did something I'm normally against - I contacted an old friend I've known for more than ten years and asked whether he wanted to go into business with me, and do the design part of the site. He has an amazing talent when it comes to design and usability, and has a cunning strategic mind. But I'm extremely wary of mixing business and friendship, often one of them will suffer severely. We went ahead anyway, and he got down to some serious design business. Unfortunately he isn't good with code, so I agreed to learn HTML and CSS and do the front-end code. He delivered some amazing designs, and we picked one. We were getting a good feel for how the site should look, feel and function.

Next I contacted a programmer I knew from two previous upstarts where he's been absolutely amazing. Codes anything from assembler to PHP, delivers code that is virtually bug-free, does so on schedule, is a member of Mensa, and overall a great guy. I always liked him, and the feeling was mutual, so it was easy to get him on board. He thought that he could do the back-end code in a month if I did the front-end code. I'd been learning HTML and CSS and didn't find it too hard so I started doing the front-end and he started doing the back-end. After three weeks there was a break-in at his house. They stole his server, his laptop, and even his sofa. Everything was stripped. Including the closet where he kept his backups on DVD's. Everything was gone.

So we started over.


I didn't want to initiate contact to the developer, thinking that he should take his time to get well before we started working again. When he called me he would be ready. That happened after two months. Having known him for a long time I could hear that he wasn't up to his good old self. But he wanted to go ahead, so we did. Things went a bit slower this time, and I didn't want to push. After a while he stopped answering my e-mails and didn't pick up his phone. I was torn between pushing for some code and thinking about the guys health and well-being which obviously wasn't good. Eventually I got an e-mail stating that he had to pull out due to personal reasons. I understood completely and wished him well. But I was back to square one.






But I carried on.



Second the income model we were using was made illegal because of a new law that was hurried through parlaiment due to issues unrelated to us. This was the definitive blow. With no near-term prospect of turnover in a country where it isn't easy to go out and get external investors aboard there's nothing more you can do.

Now that's a worst case scenario.


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April 27, 2009

Moving a boat

This is a story about what it takes to start a company. It may not seem like it, but it is.

I live on a boat in a harbour. It's an amazing place with just the right mix of artists, yacht owners and fishermen. As in all small communities there's a strong invisible pecking order. The fishermen are on top. They are the real men. They have survived force gale 12 storms in the bay of Biscay, they haul cod out of the freezing water with their bare hands in the winter, they move crates around the harbour like children moving toys across the lawn. And, of course they know all there is to know about boats. When it comes to boats they are the unquestionable authority. They have seen it all before, and they are always right. They are where you go for buying, selling, moving and fixing boats.

I like the fishermen. Without them I would have no idea how to fix all the things that inevitably break on my old boat. And I can tell they enjoy sharing their vast knowledge. But to them I'm not a real man. I'm an academic. I can't lift the heavy crates, I've never been in a real storm. And I can't haul cod, not even in the summer. To them I'm a boy.

On the outer edge of the harbour there's a small man-made island to break the waves coming in from the sea. Like many small man-made islands and piers it's surrounded by heavy stones that are piled up around the edge of the island to keep the waves from washing it into the sea. I imagine that a hundred years ago when it was established the local fishermen would start by collecting huge stones and throw them in the water from their boats, slowly building the perimeter. Once an atoll of stones were sticking out of the water they would have filled the middle with soil, gravel, and old garbage. If you dig a bit you can still find old bricks, wood and heavy chains hidden in the belly of the island. It's a beautiful island, with wild roses, long grass and willows hanging over the water. It's great for barbecues in the summer, and just perfect for chilling out. And best ot all, it's accessible from one of the piers that leads from the harbour right out to the island.

So one day when the fishermen were scrapping an old wooden fishingboat I asked whether I could put it on the island. The wheelhouse and deck was gone, and all that was left was the hull. It was pretty small for a fishing boat, around 20 feet. When I looked at it I saw the old oak planks meticolously carved out and stuck together to fit just right. Once a talented boat builder had taken a lot of pride in building it. Now it had reached old age, but it still had the smell of tar and sea, and if you closed your eyes you could almost see the old fishermen out to sea hauling cod from it. It would fit well on the island. I imagined that it should sit on the side of the island, and that there should be a small table, a few chairs and a barbeque inside it. Then you would be able to sit in the boat, looking across the railing and out over the sea, dining with friends, telling stories about storms in the bay of Biscay. It would be perfect.

So I asked the fishermen if I could put the boat on the island, and told them how perfect it would be. They smiled and agreed, and told me that if I could get it there I was very welcome. I sensed that I was somehow being held for a fool, but didn't quite understand why. So I asked what was the matter. "Listen son, that old boat weighs in at maybe a tonne, it doesn't float because it's so full of holes, the pier is too narrow to haul it across, and it's gonna be pretty darn hard getting it over the wave breaker stones. It would take at least ten strong men a day to get that done, and we've got better things to do. But if you think you're man enough we'd love to see you give it a try." They smiled. They had just told me I couldn't do it. "Doesn't seem so hard" I tried. They smiled. "Oh yeah, watch me, give me a week, and I'll be having a barbeque in the boat on the Island. I'l do it, and I'll do it without your help. Or anybody elses for that matter." More smiles. I had taken the bait, and was now on the hook.

The ruling class of the harbour had told me that this couldn't be done by boys, only men. A lot of men. And they knew, they had done this kind of thing for decades. There were unwritten rules and tricks passed from one generation to the next without much change, and according to these rules I wouldn't be able to do it. Much less do it alone. But I had to. I didn't have a choice. It was my test of mandom. My generation against theirs. And I wouldn't fail.

I knew that I wouldn't be able to do it on their terms using brute force. I knew that they were so superior to me that if I ever got in a barfight I would rather have a 50 year old fisherman than Chuck Norris on my side. I never had the guts to go to the joints where you get in barfights in the first place. I had to use my own strong sides to make up for my vast inferiority of raw strength. I had to be smart instead of strong.

So I came up with a plan. The fishermen would lend me their crane to lower the boat on to a barge for me, but the rest I would have to do myself. The plan was to get the boat to stand on its stern with the bow pointing straight up in the air and the keel pointing to the heavens. I would fasten it with ropes to the sides of the barge to make sure it didn't fall over. I would then tow the barge to the island, and moor it alongside the wave breaker stones, cut the ropes and let it fall. Hopefully it would fall with the keel across the stones, and onto the grass on the other side. From there I would use an intricate system of pulleys and sticks that could leverage my missing raw strength to pull it into place. I thought it was a good plan.

I got the boat onto the barge using the crane without much trouble. It did take me some time to secure it in its awkward position pointing straight up, but I did it. The fishermen watched and laughed. It would never work. If the keel of a boat isn't horizontal you're in trouble. It's against the unwritten rules. Nothing good had ever come from a keel being vertical instead of horizontal. I didn't care, and happily towed the spectacle across the harbour out to the island. Cameras snapped and fingers pointed my way, but I just knew it would work, so I swallowed my pride and reminded myself of who would have the last laugh.

I got to the the island, and moored the barge alongside the stones, as close as I could to the spot where I wanted the boat to find its final resting place. It was only ten meters away. When I tipped the boat from the barge I would get the keel across the stones, and the worst part would be over. I started cutting the ropes, and the boat fell, exactly as planned. Then something terrible happened. One of the ropes holding the barge to the island slipped, and the boat started drifting outwards away from the stones. It slipped down over the stones and into the water, and came to rest halfway into the sea before I could throw a rope around it and secure it to a tree.

This was catastrophic, my plan for getting across the stones had failed miserably. It was the hardest part of the venture, and I had no idea how to proceed. I knew the fishermen were expecting me to give up, and that I would have to endure their mocking for years to come. They would happily come and pick me and the half sunken boat up just to ridicule me. I didn't know what to do, but what I did know was that I couldn't fail. The stakes were too high, I had made a commitment and told everyone about my venture. My pride simply wouldn't allow me to give up.

I tried to move the boat, but it was wedged between the stones, and didn't move an inch, even when I put in all of my strength. But I knew that I had one thing the fishermen didn't: Brains. I could think my way out of this, I wasn't held down by their inbred old beliefs. I could come up with some clever scheme that would save me. Maybe their unwritten rules about what could and couldn't be done were just crap. Maybe nobody really tried to do things differently.

So I sat down on a stone and assessed the situation. The boat needed to be pulled one metre up and two across to get over the stones. From there it would need to be pulled five or six meters across grass and on to the small hill where I was determined to have a barbeque in less than a week. I had some four by fours that I could lay on the stones with one end in the water below the boat, and the other up on the grass. That way I would have something to slide it on, over the stones. On the small hill where the boat would end up there was a tree. If I tied one rope to the tree and another to the bow of the boat, and had some kind of leverage system connecting the two ropes I was sure I would be able to pull it all the way up to the tree. The rope needed to be strong, and the leverage system needed a big exchange for it to work. The boat weighed as much as a car, and it wouldn't be easy to pull it across the stones. I started working on my leverage system.

I took an old oar I had lying around and cut the upper part of it in two. Now I had two pieces of round wood. I took a length of rope and tied it to one end of one of the pieces of oar. Then I brought the rope around the tree and back to the piece of oar where I tied it to the other end. Now I had a piece of oar secured by a rope at each end in a loop around the tree. I did the same thing on the boat. One piece of oar was secured with a rope to the boat, and another to the tree. The two pieces of oar were roughly five meters from each other. The idea was that if I tied a rope to one of the pieces of oar, and pulled it back and forth across the two pieces of oars I would have a pulley system. If I put the ropes three times back and forth between the pieces my exchange would be three times. I would have to pull the rope three times as far, but only with one third of the strength. I had replaced ingenuity and hard work with raw power.

I strung the rope three times around the oar pieces, and started pulling. Nothing happened. The leverage wasn't enough. Five times. Still not enough. Eight times. That did it. The boat creaked and the ropes whined as it moved an inch or two out of the water and came to a stop. It was too hard, and I couldn't pull anymore. I took a look at my pulley system, and found a flaw. The ropes around the pieces of oar were so strecthed that I couldn't move them sideways at all. The tension as they dragged over the old oar was too much. I got an old can of grease from my boat and smeared it across the rope to make it glide easier over the oar. I tried pulling the rope again, and after a few false starts it started working. The boat slowly but surely rose out of the sea, and started its journey across the stones. It worked. It was hard work, and every half meter or so something would get stuck. I was sweating, covered in grease, working like a horse, and didn't even notice the sun setting over the harbour. I was busy doing what couldn't be done. It was midnight before the boat arrived on the little hill, but arrive it did. I was exhausted, and felt like most of my bones were broken. But it didn't matter. I had done what the fishermen said couldn't be done. I went to bed and fell into a long dreamless sleep almost before I hit the sheets.

When I woke up the next day I felt on top of the world. My body was hurting, I had ripped my trousers, and bruised my hands. But it didn't matter. I had used ingenuity, leverage, determination and hard work to achieve what the unquestionable authority of the harbour said could only be done by men. A lot of men. And I had done it alone.

In the afternoon when the fishermen came in from the sea they saw the boat standing on the small hill on the island as a monument to my triumph. I knew they would see it, because they sailed right by the island on their way in. But they never mentioned it. Maybe they couldn't acknowledge the fact that an amateur could beat them at their own game. Maybe they couldn't swallow their pride. Maybe they thought I had cheated somehow. But the result was there for all to see, and the next day I invited some good friends over for a barbeque in the boat.

Over the next few weeks I did notice small changes. I would be invited in for a beer more often, and the fishermen would tell me stories from their youth about storms in the bay of Biscay.

And whenever I looked one of the old fishermen in the eyes we both knew that he wasn't looking into the eyes of a boy. He was looking into the eyes of a man.


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April 16, 2009

Getting product pricing right

Setting the right price for a product has always been one of the most difficult hurdles for startups. Of course it only makes it worse that the pricing of your product is one of the most important decisions you as a businessowner will ever make. So how do you do it?

If your product happens to be webbased, here's an interesting idea. But first some basic economy on what the right price is.

According to classical economics the higher the price you charge for your product the less people will buy it: as prices rise demand decreases because less people are willing to pay the higher price, and supply rises since producers can get more for their wares. The market price is where the two meet. This is how a free market with perfect competition works. On a graph it looks like this:

Your goal as a businessowner is to maximise your operating income, which is the amount of money you have left when you have paid for your operating expenses. Operating expenses can be divided into variable and fixed operating expenses.

So your operating income can be defined like this:
Operating income = units x (price-variable expenses) - fixed expenses

Your fixed expenses are pay, rent, and other things you have to pay no matter how many customers you have. (Strictly speaking your fixed expenses will of course become variable as you grow since you need more people, bigger offices, etc.)
Your variable expenses are the expenses that can be related directly to how many units you sell. Support calls, server costs and delivery fall into this category. (again, strictly speaking most variable expenses are incremental: you either have one or two servers, not 1,4 servers)

Since you know, or can at least estimate, your variable and fixed expenses it is possible to calculate what your operating income is at different prices. The right price is of course the one where your operating income is as high as possible. If you had a graph of the demand curve for your product this would be easy: You could just find the price where (price - variable expenses) x units sold is at a maximum. Since you sell your product at the same price to all consumers your supply curve is vertical, No matter where the demand curve meets it the price is the same: everybody pays the same price. By changing the price you can slide your supply curve left or right. For instance, if your product costs $1 to produce you would rather sell 10 units at $5000 ($4990) than 2000 units at $3 ($4000). The problem is that you don't know how the demand curve slopes. Maybe your customers will start using your competitors cheaper product once you reach a certain price, maybe there's a psychological price barrier somewhere, or maybe a large percentage of your customers are willing to pay much more than you anticipate. You just don't know for sure.

If the demand curve goes like this the best option may be to sell expensive to a few customers that are willing to pay big bucks.

But if your demand curve goes like this you will be better off selling cheap, since none of your customers are willing to pay in buckets, but a large amount are willing to pay a decent amount.

Since there's really no way to know, except experience and looking at your competitors pricing most people and corporations just guess. Sometimes highly paid consultants are brought in to make a better guess. Large companies like Procter and Gamble have teams of experts committed to the game of guessing a price.

But for upstarts that sell their wares on the net there might be a better way.

Let's say you start a company that sells socks on the Internet. You have one product: a ten-pack of beautiful blue socks. Your competitors sell ten socks for ten bucks. so should you follow their price, make it cheaper or more expensive?

Webbased companies have done A/B split testing for many years to optimise their sites. The idea is that you show 50% of the users one page and 50% of the users another page and see which one performs best. Performance is usualy measured in terms of how many people buy something. Using this method you can continually test your site, try out new ideas, and micro-optimise it. Amazon is known for doing this.

What if you do split tests to optimise your price?

If you have a lower bound and an upper bound for the price of your ten socks you can hack a splittest together that will find the optimal price. The lower bound is the variable expense for the socks. The upper bound is a really high number. The program will start with a series of price points evenly distributed between the upper and lower bound. It will show a price of $10 to some customers, $8 to others, and maybe $20 to others still. Since you can capture how big a percentage of potential customers accept the price (by entering their credit card information and buying your socks) at different prices you will be able to micro-optimise the price. Using splittest technology and clever hacking you can actually test your way to the perfect price.

You start off with random values between the upper and lower bound, calculating your potential operating income for each price.

Let's say you have 1000 visitors that are shown five different prices randomly, and thus have different percentages of accepting the price - the higher price the less visitors will buy.

Percent that buy socks:30%25%22%19%14%
Turnover for 1000 visitors:$2400$2500$2640$2660$2240
Variable cost
for 1000 visitors:
Fixed cost:$1000$1000$1000$1000$1000
Potential operating income
for 1000 visitors:

This will give you a rough demand curve with five pricing points: $8, $10, $12, $14 and $16. And from this you can see in which range the optimal price is. In the above example it is obvious that the optimal price point is somewhere around $14, since that is where the operating income is maximised. Now you can repeat your test in the $12 to $16 range, and iterate with smaller and smaller numbers until you find the perfect price.

I'm not oblivious to the potential problems of this approach, namely that in the test phase a number of customers will get wildly varying prices. There are a number of cases where this might be undesirable: It could affect your brand, customers might get angry hearing that they've paid twice as much as someone else, etc. But to get a statistically significant result you will probably not need to run that many visitors through the test. And I think it's worth it if you know that the price of your ten socks is the best it can be.

What do you think? Will it work? Is it insane?

And if you're thinking about actually building something like this shoot me an e-mail at max@maximise.dk. I'd love to consult :-)


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March 26, 2009

Let the engineers rule

For the last decade the people that have had success have primarily been bankers, brokers and othe money-pushers. I think the current crisis will mark a big shift in where money and power is centered. It will pass from financial engineers to real engineers.

Barack Obama has on The tonight show pinned the zeitgeist with this quote "What we need is young people instead of them wanting to be an investment banker we need them to decide they want to be an engineer"

In a free-market society the individuals that make the most wealth are the ones that should prosper and make the most money. Wealth isn't the same as money - money is an intermediary form of exchanging goods and services, wealth is, according to Paul Graham "stuff we want: food, clothes, houses, cars, gadgets, travel to interesting places, and so on" Creation of wealth is the innovation of goods and services that drive society forwards, and is what should be rewarded.

For the last decade society has mistaken the creation of money for the creation of wealth.

We believed that bankers and brokers must be innovationg and creating products that drives society forwards simply because they were so financially successful. Their money also made them something to aspire to. If you wanted to become rich and powerful finance was the way to go. But we were fooled - the financial industry didn't create wealth, they merely printed money and built ponzi schemes. And they kept most of the money themselves.

Money is power. Power corrupts. Absolute power corrupts absolutely.

Douglas Adams has a great story about power in The restaurant at the end of the universe. The heroes of the book set out on a quest to find the true ruler of the universe, which is not as easy as it seems because of an insight the galactic rulers have had eons earlier: The man who most wants to rule the universe is the one that is least suited to do so. Absolute power corrupts absolutely. So a sneaky scheme has been devised: The ruler of the universe doesn't know, or care for that matter, that he happens to rule the universe. He lives in a small shed on a far-off planet and people in spaceships come to ask him questions every now and then. His answers are, unbeknownst to him, what rule the universe.

This is of course a comedy, but like all great comedies it holds some significant truths and insights. And this one may be the biggest of them all.

What Douglas Adams is pointing at is that the people who want money and power are the ones most likely to get it, qualifications play second fiddle to ambition. And the financial industry has been very ambitious indeed. And they ruled the universe until it all came crashing down because it was exposed that they didn't create wealth, but merely printed money for themselves.

So there is a vacuum in power. The financial industry has been broken, Wall Street humiliated and many of the players have gone bankrupt. Society must, of course, move forward and someone must carry the torch that has been taken from the bankers and brokers. And the ones that should carry the torch should be the ones that create wealth.

So who creates wealth? In short: People and companies that make stuff better than before. The innovators and the engineers. The Googles, the Xobnis, the reddits and the Linus Thorvalds of the world. The ones that make our life easier, better or more enjoyable. They are ultimately the ones you depend on for your car to run, your house to be heated and your Internet to work. And they are the ones that truly drive society forwards.

But many innovators and engineers suffer from one problem in relation to power: they aren't the ones who want it the most. Linus Thorvalds has no ambitions about building a global multimillion dollar powerhouse, in fact he gives his products away for free.

If we don't want to be caught in the same trap as we are now in ten years time the innovators and engineers should be the ones that hold the power, simply because they are the ones that truly drive society forwards.

I see two solutions.

Either the engineers will have to step up to the plate and start playing the powergame - people like Larry Ellison show us that engineering and powergames aren't exclusive.

Either that or the rulers of the universe should be engineers livíng in sheds on faraway planets where strange people come to ask them questions about life the universe and everything.


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March 09, 2009

Online news and the prisoners dilemma

Would you pay for a newssite on the Internet? If you won't you're in the vast majority.

But what if we rephrase the question. Would you pay for a newssite on the Internet if there was no other free alternative? The answer would probably be yes, since there would be nowhere else for you to get that constantly updated dose of news that you're probably addicted to. So for a consumer a newssite is obviously worth paying for - yet publishers can't charge a dime for their content.

Quite a paradox.

Here's how the whole thing has played out in the real world, and why news has ended up being a free commodity you can't charge for, even though it has value for the consumer and a very real production price.

Back in the 90's publishing houses were worried. They saw the Internet coming, and it was obvious to them, and everyone else, that news was a natural fit for the Internet. They also saw that this would eventually doom their hundred year old income model of selling a daily paper made out of dead wood. But they didn't know exactly how it would play out, what technologies to bet on, what kind of news would work on the Internet, and who would ultimately be the winners and losers of the coming great news war. The only thing everyone agreed on was that the whole industry would change dramatically.

So many publishing houses were proactive and launched newssites early on that were updated often. This is the New York Times from november 12, 1996 Since they were still in the experimental phases the news was free. Besides there weren't really any good ways of charging users for this new beast of a technology.

Eventually more and more publishing houses started getting an Internet presence, and their sites grew and were updated more often. None of them saw this as an income model yet, but they all acknowledged the potential and importance of having an online brand.

As more users joined the Internet the big newssites started to get more and more traffic, and entrenched web properties such as www.nytimes.com and www.cnn.com were established. Consumers loved it because they could now get constantly updated news for free.

Eventually, a few years ago, online news started becoming so mainstream that a majority of people would start checking news online several times a day. Many of them also started cancelling their daily subscriptions. This was, of course, expected. The quest was to move as many users as possible to your online property, and losing as few subscriptions as possible in the process. "Onwards and Online"

The next step in this evolutionary tale was to start thinking about income models. It was obvious that advertising alone would not hold up the expensive machinery of a news organization, so some kind of subscription model was inevitable. And planned.

And this is where the problems started.

Consumers had gotten used to online news being free. This is what they had come to expect, because this is how it had always been in the past. So they barked and often refused to pay for online access. The implicit threat made by the consumer when a newssite would start charging for content was "OK, I'll just move on to your competitor, who covers pretty much the same news and has a free site". The ramification of this was that the sites that charged for online content would be decimated by the ones that offered free content. And there would almost always be a competitor that was free.

This is the classical game theory problem of the prisoners dilemma. It goes like this:


These are the possible outcomes of the game:
Prisoner B Stays SilentPrisoner B Betrays
Prisoner A Stays SilentEach serves 6 monthsPrisoner A: 10 years
Prisoner B: goes free
Prisoner A BetraysPrisoner A: goes free
Prisoner B: 10 years
Each serves 5 years

So the dilemma is whether you can trust your partner. If yes, you can choose to stay silent and get 6 months. You can also betray him, and go free. But if your best choice is to betray him, why should he trust you? If you betray him, and he betrays you you both get 5 years.

A dilemma indeed.

This is the problem online news is faced with. Here's an example of an online world with two news sites. The combined ad revenue is $2 million, and if there is no free alternative ten million users are willing to pay $10, a total of $20 million in subscription charges.

Site B doesn't chargeSite B charges
Site A doesn't chargeThey share $2 million in ad revenueSite A gets $2 million in ad revenue:
site B gets nothing
Site A chargesSite B gets $2 million in ad revenue:
site A gets nothing
Site A and B share $22 million in ad and subscription revenue

If there is a free alternative consumers won't pay for a subscription, so if the sites don't cooperate they will share the $2 million in ad revenue, since the potential income from subscriptions will never materialise because there is a free alternative. But it is to their advantage to trust each other and share the additional $20 million in subscription revenue. In a game with two players they might get together and agree to charge.

But what happens when a new player enters the market. Suppose the two sites have agreed to charge. A new player that enters the market with free news will instantly take away all the customers, because the new service is free, and the new player will get the $2 million in ad revenue. If the old players can't convince the new player to start charging they only have one choice: revert to the free model.

The problem, of course, is that there are a lot of sites out there, and making each and every one of them agree to charge is almost impossible, and probably illegal. If just one site defects it will instantly take over the whole market and get all the ad revenue.

This is the problem that online news faces today.

So what can publishers do?

The theoretical game assumes that all newssites are equal, and can be substituted for one another. This is not always true. Gossip newssites are pretty generic, and the same pictures of Brangelina will inevitably appear on all of them with pretty much the same captions. These sites are to a large degree interchangeable, and thus hard to charge for. But newssites with unique content that is valuable to a consumer and is not easily interchangeable for another newssite can get away with charging for their product, even though the competition is free. The requirement is that the consumer finds that the site is not interchangeable with other newssites. The Economist have managed to do this by giving in-depth coverage, wit and editorial not found elsewhere on the net. Users are willing to pay for it, since there is no obvious substitute.

So if you want to do online news you either have to provide something valuable noone else provides for free, or rely on ad revenue.

Oh, and this analysis applies to most online markets. If you're bright you might even see how this implies that many VC's are a hinderance to online business...


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