Stanford AO Summit, July 19-21, 2005

Overview

Very interesting and stimulating conference, aiming to define the broad agenda for the coming years. Wide-ranging program and crowded schedule combined speculative musings of gurus such as Bill Joy, George Gilder or Jason Lanier with assembly-line pitches of CEOs of new companies competing for the CEO Pitch award. Similarly the tone of meetings varied from enthusiastic next big thing hyping of Tim Draper (for Skype) for gimlet eye straight talking of other VCs. Networking opportunities were endless, as everybody was informal, approachable and name cards were all in capital letters. To keep us from getting too pompous and self-important, all proceedings were accompanied by real-time blogging, which provide not only a degree of mischief but also a running and sometimes surprisingly pertinent commentary.
I took in the following messages:

• Mobile is going mainstream


• Open source is at the tipping point


• Software is dead, long live s-as-services


• Ignore blogging at your own peril


• Business model remains the (unspoken) Holy Grail.


• Business angels have disappeared

Mobile is going mainstream

Mobile data is no longer a pipedream and the eternal application of the future. Mobile telcos migration to CDMA is well under way (considerably more advanced than in Europe), which means mobile transmission speeds comparable to DSL or cable. Furthermore, the penetration of high-end smartphones (Motorola) and PDAs (Blackberry and Palms) is high and growing rapidly.
Mobile rated a separate session, which was well attended and focused primarily on content. Three of the mobile panel participants were from large IT companies (Macromedia, ATI and Seagate), which are not usually associated with mobile. It is interesting to note how many big telecom players attended the summit (Vodaphone, Verizon, France Telecom, SwissCom, Qualcomm, Motorola, Nokia among others). As interesting was the importance of mobile among promising new businesses. Thus, the founder of Electronic Arts, Trip Hawkins, has set up a new company, Digital Chocolate, which presents itself a developer of innovative mobile phone applications. There were several mobile-focused companies among those pitching for CEO Pitches award. Among those Enpocket (http://www.enpocket.com/) appears of particular interest.

Open source is at the tipping point

Open source movement has long gone beyond Linux and reflexive anti-Microsoft reaction. It is now seen, at least in that crowd, not only as a robust operating environment but also a preferred development platform. In a striking reversal of roles, defenders of proprietary systems (in this case, Sun Microsystems) are now on the defensive and have to argue the benefits of their solutions.
For a layman such as myself, it is the widespread adoption of open source as the application development that is striking. Thus, Google uses primarily open source tools for their application development. One of the CEO Pitches companies, Jaspersoft, provides open source reporting solutions, which are used by some 10 000 companies in over 50 countries. And of course IBM, is strongly pushing open-source solutions.

Software is dead, long live s-a-services

One of the consequences of the inexorable progression of open source is a radical transformation, maybe even the withering, of traditional software business. Ray Lane, ex-COO of Oracle and now a partner at leading VC house, KPC&B, expounded at such a length on the subject that he took practically a third of panel’s time. He and those panel members who managed to speak all agreed that between the open source and internet on-demand delivery, the traditional and long-time successful way of designing, selling and deploying software no longer works. Why would anybody pay for Oracle DB when one can have MySQL for free? While the software industry is apparently consolidating through mergers and acquisitions, the true dynamic is that of balkanization. A stock response to new challenges is the vision of software as service. However this vision covers a variety of actual offerings, from on-demand delivery, through specialisation in features such as high-performance, scalability of security to outsourcing (which in itself comprises a wide range). The bottom line is a major shift of pricing power but also of responsibility to the user. More and more platforms and solutions will be created in-house. Buy or built dichotomy has now become a closely integrated pair.

Ignore blogging at your own peril

Blogging is ubiquitous. While it was a subject of a dedicated panel, scheduled as a grand finale of the Summit, it was the underlying theme of at least two other sessions. And, as mentioned above, bloggers provided a running lively commentary on all Summit events. Jonathan Schwartz, Sun COO, has it absolutely right when he says that a CEO who does not blog makes the same mistake as one that does not use e-mail and in few years non-blogging CEO will be an extinct species. Few years ago, many journalists used paper publications as a primary channel of expression and blogged only occasionally. Today, an ever increasing number are blogging first and writing classical articles second. This is the case for Dan Gilmor, formerly from San Jose News (and Financial Times) and now from Grassroots media
Blogs resemble e-mail in its viral propagation and ease of use. On the other hand, they are a considerably more complex phenomenon. In addition to the communication function, they are a vector of content and therefore a major influence on the shape and structure of media. Maybe it was a coincidence but during our stay in Palo Alto, both New York Times and Dow Jones announced that their online revenues (and profits) are growing much more quickly than their print revenues. And they have not even begun to comprehend let alone integrate the blog phenomenon.
Clearly, as impressive as it is already, blogging is at a very beginning of its trajectory and its evolution remains quite open. Thetwo big challenges are: the structure and hierarchy of blogs, on the one hand, and the blogging economy on the other hand.
Blogs are a do-it-yourself media, incomparably more egalitarian and free-flowing than the editor-controlled content. Nevertheless, unless some of the blogs are read more often than the others and a structure of readership and links emerge, it will remain an atomised and chaotic space. Some of the most interesting initiatives are seeking to act as catalyst to such a structure by providing search and linkages facilities and acting as blog aggregator. This is the case of Technorati or Blogdex. They hope to become the Google of blogosphere. Not surprisingly, Google has the same ambition. One advantage it has, in addition to its formidable brand pull, is it content monetizing expertise. However, this is far from foregone conclusion. Everybody agrees that RSS is a key to blog monetisation and many companies are seeking to acquire and enhance their RSS expertise.
Business model remains the (unspoken) Holy Grail.

Although there was no dedicated panel on evolving business models, it was clearly a major theme of discussions about software, services and medias. Growing emphasis on services and medias entail increasing recourse to indirect revenue generation (selling services and advertising rather than access and products). Multiple revenues streams appear as a rule rather an exception. Moreover, all business models need to be continuously monitored and modified. According to Ray Lane, one cannot sell software today the same way it was sold in the 1990s. Online advertising evolves continuously: search remains a strong vector of growth but new forms are emerging. As we know, leading search services providers, Google and Yahoo, are now looking at new forms of subscription models.

Business angels have disappeared

There were two panels with moneymen. The overriding impression from these panels was the persistence of risk aversion. Venture capitalists continue to be driven by a herd instinct: they all want to be in China and in Life Sciences. They are reluctant to put money into companies that need money and consequently they demand exacting conditions (in particular a controlling equity stake). The only exceptions are companies, such as Google, that do not need money.
CEP Pitch competition was a striking example of this mentality. It was won by a company, Peerflix, which proposes DVD exchange, not through streaming or burning, but by shipping them in paper envelopes. Nice idea but very far from innovative.
Another example was hyping of Skype, the free IP telephone service, a cross between Napster and Hotmail. It is backed by the same VC, Draper and Jurvetson, who invested in Hotmail. I am pretty sure that they will get a very handsome return on their $10 million investment. But from there to assert that Skype will revolutionise the telecom industry (which already starting to deploy VoIP on a large scale) is a mental leap I would not make.
Persistent risk aversion has led to the quasi-disappearance of angels, willing to invest in early, innovative stage ideas. As a result, many entrepreneurs, including those with a previous track record, are now relying on bootstrapping as the primary way of raising capital.
This being said, there are features of the Silicon Valley VC scene, which are worth emulating. One is the CEO Pitch. As usual, the audience is as interesting as the judges or presenting companies. It is a pity that the audience did not have a vote. It might have led to different winners.
Other feature is the entrepreneur in residence, who is hired by leading companies to develop and launch new businesses. We met two such entrepreneurs at the Summit and those were among most interesting contacts.

Google is not a bubble


The strong run-up of Google stock price since its IPO last summer - its market cap has increased more than 300% since first listing - has prompted a rash of comments among market watchers. The prevailing view, particularly in Europe, is that Google market performance is just an unwelcome return of the Internet bubble phenomenon of late 1990s and early 2000. I beg to differ. I believe that Google’s meteoric rise reflects a reasoned view of its current position and of its future prospects. This is based on two considerations

Google is a top tier e-commerce company

Some analysts compare Google to companies such Webvan or boo.com or excite, ephemeral stars of the Internet boom. This is a mistaken comparison. Google is a top-tier company: its peers are the Three Musketeers of e-commerce (Yahoo, E-Bay and Amazon). If one looks at their long-term market evolution (since their IPOs), they have very largely outperformed broad market averages (and this takes into account occasional but quite brutal corrections all of them experiences particularly in the aftermath of the NASDAQ crash of 2001-2002). Anybody, who bought these stocks at their respective IPOs has made a return superior to 2000%.

Incidentally, this is not an unique phenomenon: if one looks at the top-tier companies of previous generation, such as Microsoft, Oracle, Intel or Dell, one can see a similar price behavior, where market leaders strongly and durably outperform market averages.

Current market is highly selective

During the bubble days, strong tide lifted all boats, solid ones as well as shoddy ones. This is not the case today. The market has become highly selective and discriminating. Google’s performance stands out because:
a. Broad market has been trading in a narrow range
b. Three musketeers have been underperforming recently, Amazon and E-Bay, more than Yahoo. This differentiation also demonstrates that investors are continuously evaluating prospects for each company and form distinct judgments about them.


Key performance factor: Google’s business model

From these considerations it follows that a higher ranking of GOOG is not based on a mindless whim or a sheepish investor behavior but on a reasoned judgment.
The question is what are the reasons for such, strongly bullish, judgment?
It is not primarily or exclusively the pertinence or elegance of GOOG search algorithm. Although, it is innovative and sophisticated, it is possible even likely that some lab or a start-up may come with a better mousetrap. Nor is it its popularity among users, always a fickle phenomenon. Nor is even its stellar financial performance (to the extent that this performance is a result rather than a cause of Google’s strategy).
The key explanatory factor is its core business model. It is this model that powered it to the top of online advertising. However for Google, the objective is not to become a biggest advertising agency in the world, although it may attain this position anyway.
In contradistinction to YHOO, it is not a media or eye-ball aggregation company. What Google is all about it is about monetizing information. We have all known for long time that information is the most valuable resource of the web. But, because of a widespread unwillingness to pay and conceptual difficulties of pricing it, the value of information was not being captured. It is in this area, that Google achieved a real practical breakthrough.
Its advertising programs provide not one but a series of mechanisms to fix, extract and transfer the value of information. It does so in full recognition of economic peculiarities of information: elusiveness, volatility, reluctance to pay. Google valuation and transaction mechanisms rely on third party payments (through advertising), dynamic pricing (auction) and pragmatic mixing and matching (paid search, contextual advertising, local advertising, etc).

Overshooting and undershooting

While the relative ranking of Google appears well-grounded, the questions of speed and magnitude of Google appreciation remain. It is difficult to ascertain whether its current price reflects its fair value. Furthermore, if past experience is any guide, violent price swings can be expected. The evolution of Google’s market price and valuation reflects an intense interplay of available information and constantly evolving expectations. Furthermore, equity markets today are not only anticipatory but they seek to cash in on those anticipations. This creates a continuing risk of overshooting or undershooting (like in the FX markets): the price is either too or too low. However in this case, there is a clear and rational upside trend.

published on Interactive Investor (www.iii.co.uk)

Israel: Politically incorrect development success story

Few weeks ago, I visited Israel, after a seven-year hiatus. As usual, I travelled along the Mediterranean coast and to Jerusalem and met with family and business friends. I must admit I was surprised. I anticipated a country slowly and painfully recovering from the intifada. Instead I found an economic dynamo. Israel appears to be doing well. My friends are again vibrant and optimistic. And visual impression is striking : starting with a brand new airport, then driving on new roads and highways (not that traffic has improved much) and stopping at huge shopping malls. Everywhere new buildings, modern offices and an ever increasing variety of residential dwellings. The property and construction is also in apparent in Israeli Arab villages and towns. I am talking about places such as Ben Hanana, Megadim or Nazareth, situated within pre-1967 borders and whose inhabitants are Israeli citizens. Picturesque terrace houses are being replaced by sprawling multistory villas. Village mosques are lavishly renovated. We are worlds away from the prevailing picture of shantytown squalor.

My Israeli friends told me that Israeli Arabs are doing quite well, with growing cadre of professionals, doctors and engineers. Although politically they are predominantly left-wing, with five or six parties to choose from, they are not very keen on being assimilated with Palestinians and dread falling under their jurisdiction. There are practically no volunteers among Israeli Arabs to work in areas under PA jurisdiction and even less to live there permanently. Interestingly, in the post-July 1967 territories, 80% of Palestinians affected by the construction of the security barrier in West Bank choose to live on the Israeli rather than on the Palestinian side of the barrier.

As impressions can be misleading, I decided to check data and statistics on the Israeli economy in general and about Israeli Arabs in particular. Factual checks and data perusal not only confirm my impression and make it a clear that Israel is an astonishing development success, on a par with Ireland, Taiwan or Singapore.
At present, Israel is growing at some 4% per annum and its per capita income is raising at an annual rate of over 2% per year.
But that is only a beginning of the story. Israeli GDP/per capita is way above that of its neighbours: Based a Purchasing Power methodology and World Bank data for 2002, it is more than five times that of Egypt and Syria and more than four and half times that of Lebanon and Jordan. In the region, the only countries with a comparable standard of living are Cyprus (whose GDP per capita is about five percent lower), Bahrain, Quatar and Arab Emirates in the Gulf (the last two are the only countries in the region with higher GDP/per capita than Israel). Interestingly, the best-known oil producers, Iran, Libya, Saudi Arabia all lag far behind Israel in GDP/per capital stakes. By the way of comparison, Israel’s standard of living is higher than that of all new members as well as that of Greece and Portugal.

Israel performance is impressive not only in purely economic terms. According to the 2004 Human Development Report produced by the UN Development Program, Israel is part of the group of the 55 countries (out of the total of 177) which achieved a high level of human development. It is ranked 22nd, ahead of Greece, Portugal, Singapore and Korea. Only other countries from the region in the same group are Cyprus, Bahrein, Quatar and Arab emirates.
Israel neigbhours, as well as Palestinian population, are all part of the medium Human Development group, with Lebanon ranked 80th; Jordan, 90th; Palestine territories, 102nd Syria, 106th and Egypt, 120th.
This all looks good for Israelis. But what about Israeli Arabs? Data from Israel’s Central Bureau of Statistics provide a great deal of info. They paint a mixed picture of a glass half-empty and half-empty. The glass looks half-empty: Israeli Arabs are worse off than their Jewish counterparts on practically every relevant parameter: their infant mortality is higher, their life expectancy shorter. Their average wage is about 70% of Israeli Jews.
However, before screaming about discrimination and racism, one should consider the positive aspects – the glass half full. In particular, while below the Israel average, the average income of Israeli Arabs is considerably, very considerably, higher than that of Egyptians, Jordanians, Syrians or Lebanese. More significantly, it is incommensurably above that of Palestinians. Similarly, while the infant mortality and life expectancy of Israeli Arab lag that of Israeli Jews, they are way ahead of people in Arab countries, particularly as regards infant mortality.
As for the wage differential, these could be explained by two factors: a higher educational level of Israeli labor force (60% of which have more than secondary education compared to 26 % of Israeli Arabs) and a heavy concentration of Arab labor force in low-paying construction jobs (a quarter of all Arab male jobs). This interest in construction may explain that the dwelling ownership is higher among Arabs (87%) than among Jews (67%).

All things considered, Israeli appear to be doing a highly creditable job of integrating Arabs into their economy. On the face of it, they are doing better than the French and can probably give the British a run for their money. It is highly significant that while Israeli Arabs are in their great majority opposed to the Israeli policies, to date not a single suicide bomber has been an Israeli Arab.

It is probably too much to ask of their neighbours to take a close look at Israeli economic policies with the view to see what lessons they could apply to their own economies (and I am sure there are plenty).

On the other hand, western media and development institutions, presumably less inhibited by ideological bias and vested interest, should shed their political correctness and devote more attention to the Israeli model. This is after all as good example of ‘knowledge economy’ as one is going to find, built on high-quality mass education and close integration of research and development.

It was somewhat ironic that I was in Israel during the G-8 summit, which extensively debated the Africa case. Some time ago, many African countries had close economic relationships with Israel, which focused particularly on agriculture. Then, under political and financial pressure from Arab countries, ties were severed in exchange for promises of huge inflows of aid. As one looks at the results, this looks like a clear case of fool’s bargain.