Thursday, April 2, 2009

Scrambled Eggs

Josh Kopelman of First Round Capital has, as one of his investment maxims, a belief in investing in companies which have the potential to shrink markets. He's right and I have often looked smart by quoting him.

I was in a board meeting the other day and the CEO was explaining that positive sales momentum was around the simple value proposition of offering enterprise customers a 75% discount to existing vendor prices, while offering a comparable SLA (Service Level Agreement) and a better end-user experience that positively affected our customers revenue. It was a perfect opportunity to quote Josh again.

As background, the company is in a multi-billion dollar revenue market, so there is plenty of market to shrink. But, while we were discussing the implications of shrinking the market (and I was quoting Josh), from the back of the room came a lonely voice of wisdom. The VP of R&D meekly chimed in that we were not really shrinking the market, we were expanding it. True, our customers were drastically cutting their bills. True, their customers were getting better service. But (and there always is a but), the implications of the first two points is that much more content than planned is coming on-line. Therefore, though the ARPU (average revenue per unit) was in deep decline, the number of units looks to greatly increase and the Company should be able to achieve margins 25% higher than the previous generation of vendors.

I don't think the gross market size will settle at 25% of today's level; but it seems logical that a 50-75% level seems likely. Of note, new vendors seem poised to take a 50% share of this redefined market definition. With the enhanced capital efficiency we are seeing each day, it's worth tumbling the dice

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