"$500,000 Is the New $5-Million"

Within 24 hours of each other, both The Wall Street Journal and The New York Times wrote pieces on "then and now" re the dot-com bubble.  Surely unintentional as it was, I think they provide nice counterpoints to each other, and also give us a small window into what "innovation" means.

Since the WSJ's piece was first (yesterday), let's recap its highlights:

• Recent economic research suggests that "rather than having too many entrants, the period of the Web bubble may have had too few; at least, too few of the right kind."
• The "right kind" were precisely those startups that eschewed the reigning wisdom of the day, summarized by the slogan, "Get Big Fast."  After all, there's only room for so many Amazon's, eBay's, and Yahoo's.
• The most successful startups—survivors today—were niche spots like wrestlinggear.com, which sells equipment to high-school and college wrestlers.  But by definition it's never going to "get big," and certainly not "fast."
• "It turns out there were lots of nooks and crannies for entrepreneurial action," says Prof. Kirsch. "But those nooks and crannies might have been $5 million or $10 million businesses -- well worth doing, though not necessarily for VCs."  ("Prof. Kirsch" is David Kirsch, professor of management at the University of Maryland's business school and one of the authors of the study.)

Today, the NYT weighed in with "For Start-Ups, Web Success on the Cheap," which recounts the now-familiar (to me, at least) contrast in startup costs today vs., say, in 1999.  Using the cross-platform IM company Meebo as an example, they recount that it was started by the three founders each contributing $2,000 from their credit cards.  A month after its debut in September 2005, it was getting 50,000 log-ins daily and needed more servers:  Angels then stepped forward with $100,000, and only after it was well on its way did a "real" VC firm, Sequoia Capital, get a seat at the table.

Likewise, Joe Kraus, founder of the hot/not Excite.com during the boom, said it took $3-million in servers and software to get Excite launched, but his latest, JotSpot (just acquired by Google, terms undisclosed) needed a mere $100,000.   The primary reason?  Dirt-cheap open source software running on commodity Intel (or AMD) hardware, as opposed to Sun Solaris server farms with proprietary everything. 

Of course, not everyone's happy with this plum state of affairs:  The VC 's, in particular, are suffering a disconnect between the scale of their business model and the scale of today's startups.  Here's the problem in a nutshell:

"The problem is that as a VC, these companies don't soak up enough capital," [Paul] Kedrosky [a venture capitalist and blogger] said.

To succeed, a firm with a $250 million fund needs a handful of investments from $10 million to $15 million that can return payouts of $150 million or more, Mr. Kedrosky said. But even a twentyfold return on a $1 million investment will not do much for the success of a large fund, Mr. Kedrosky said.

For smaller funds, the economics are far different. For starters, those who manage them do not earn huge management fees. Instead, they are almost always among the largest investors in the fund, so they will earn a return if the investments pay off. “I think large venture funds in this economic model have a challenge,” said Josh Kopelman, managing director of First Round Capital.

Or, as Michael Maples, himself head of a $15-million venture fund that targets small footprint investments, puts it, "I came to the conlcusion taht $500,000 was the new $5-million."

All well and fascinating, you are probably saying to yourself about now, but what has this to do with law firms and innovation?

This:

• Successful innovations are by and large not Big Expensive Bangs, but small, niche experiments—"nooks and crannies," as Prof. Kirsch puts it.
• "Fail early and small" beats "fail late and big."
• Likewise, "win early and small" tends to lead to "keep winning, incrementally bigger and bigger."

So when you're considering "innovation" at your firm, let a thousand flowers bloom.  But have the discipline of the steel-nerved trader (the only ones who survive):  Be merciless about cutting your losses, but be profligate about letting your winners run.

Successful innovation, in other words, is for agnostics. Admit that you don't know in advance what will work.  (If you did, would you be practicing law?)  In the long run, only the market (your partners, your clients) will tell you whether an innovation is a hit or a dud; so the more experiments you can seed, the better your odds of some significant victories.   And then, sure, you can say, "I knew it all along...."