Redeye VC: Shrink a Market!
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Josh Kopelman
Managing Director of First Round Capital.
espite being coastally challenged (currently living in Philadelphia), Josh has been an active entrepreneur and investor in the Internet industry since its commercialization. In 1992, while he was a student at the Wharton School of the University of Pennsylvania, Josh co-founded Infonautics Corporation – an Internet information company. In 1996, Infonautics went public on the NASDAQ stock exchange.
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Shrink a Market!
On the First Round Capital website we write that: "W e love investing in technologies and<br>business models that are able to shrink existing markets. If your company can<br>take $5 of revenue from a competitor for every $1 you earn – let's talk! " I’ve often been asked what we mean by that –<br>so I thought it would be a good topic for a blog post.
My first company, Infonautics, was an online reference<br>and research company targeting students (mostly high school students). While I was there, I got a firsthand<br>education on “asymmetrical competition.” In 1991, when we started Infonautics, the encyclopedia market was<br>approximately a $1.2 Billion industry. The market leader was Britannica - with sales of approximately $650<br>Million, they were considered the gold standard of the encyclopedia market<br>containing “over 44 million words” written by scholars and “more than 80 Nobel<br>laureates”. World Book Encyclopedia was<br>firmly ensconced in second place. Both<br>Britannica and World Book sold hundreds of thousands of encyclopedia sets a<br>year for over $1,000.
However, in 1993, the industry was permanently<br>changed. That year Microsoft launched<br>Encarta for $99. Encarta was initially<br>nothing more than the poorly regarded Funk & Wagnall's Encyclopedia<br>repackaged on a CD – but Microsoft recognized that changes in technology and<br>production costs allowed them shift the competitive landscape. By 1996 Britannica’s sales had dropped to<br>$325 million - about half their 1991 levels – and Britannica had laid off its<br>famed door-to-door sales staff. And by<br>1996 the encyclopedia market had shrunk to less than $600M. In that year, Encarta’s US sales were estimated at $100M.
So in just three years, leveraging a disruptive<br>technology (CD-ROM), cost infrastructure (licensed content versus in-house editorial teams), distribution model (retail in computer stores versus a field sales force) and pricing model ($99 versus $1000), the encyclopedia<br>market was cut in half. More than half a billion dollars disappeared from the market. Microsoft turned<br>something that Britannica considered an asset (a door-to-door salesforce) into a liability. While<br>Microsoft made $100M it shrunk the market by over $600M. For every dollar of revenue Microsoft made,<br>it took away six dollars of revenue from their competitors. Every dollar of Microsoft’s gain caused an<br>asymmetrical amount of pain in the marketplace. They made money by shrinking the market.
[It is also interesting to note how distruptive business models have continued to impact the encyclopedia market - anyone care to guess what Google and Wikipedia have done to Encarta sales in the last few years?]
At Half.com, we tried to do the same thing. We quickly learned that most readers of<br>fiction books finished reading the book within two weeks after purchase. So we launched a very simple feature on our<br>site. Say you purchased a John Grisham<br>book from half.com for $15 (versus a market price of $30). Two and a half weeks later you would receive<br>an...