by Gabor Cselle, San Francisco, California, November 22, 2007

Most revolutionary new technology products and Internet services come from a handful of large companies and small startups. What’s the secret sauce?

Successful and profitable large companies such as Apple and Google invent and produce such products as the iPod, the iPhone, Google Maps, and Gmail. In contrast, startups have developed products and services such as Google Search (back when Google was a startup), Hotmail, PayPal, YouTube, Blogger, Facebook, and Twitter.

Users and the press rave about these products, and they have generated large valuations and profits. How does this kind of product innovation happen?

In this article, I’ll contrast product development at large and small companies. I’ve experienced product development at Google (where I worked on Gmail and some unmentionable projects) and Yahoo (where I interned at the end of the last bubble). I’m currently working on my startup, Xobni, where my role involves development as well as setting engineering and product priorities. We’re a small team of 10 people and are building new ways to search and navigate your email. Thus, I’ve seen both ends of the spectrum.

Between the two extremes of small and large companies, there are a few common denominators:

• Both types of companies start with good people who are smart, well-educated, and passionate.
• They provide good tools: High-end workstations, great infrastructure, and good benefits.
  For example, Google will pay employees for health insurance, serve free food and drinks, coupons towards buying hybrids, gym memberships, and the like.
• They set a culture that is centered on engineers.
  Engineering is the scarce resource, as it hard to find excellent engineers who can create great products. Openly or covertly, PR, Marketing, Sales, and HR are seen as second-rate citizens. This is most clear at Google, where engineering is kept on the main campus, but HR and PR are located in “Siberia“: office buildings so far away that employees have to use bikes and scooters to commute to meetings.

Most people think of “innovation” as “ideas”. But there’s no lack of good ideas. At Xobni, we have an internal Wiki page with hundreds of product ideas. At Google, there’s the ideas mailing list on which you can find thousands of employee-submitted proposals for new features and new products. I’m sure that Microsoft has an equivalent tool. But anyone who has added to that Wiki, or written to the ideas list knows that they are the place that ideas go to die.

What really counts is execution: At large companies, the ideas that survive have a strong proponent who will get support for the idea, find colleagues to work on it with, defend it in meetings, and launch it to a public. This is what happened at Gmail: Paul Buchheit started working on a webmail client, found others to work with, defended it against VPs who said that an ad-supported model would never work, and managers who said that it is prone to extinction because of Microsoft’s control of JavaScript. At startups you’ll find the same process (but less meetings): Xobni’s most popular feature is search. It was two of us who took it from a feature added as an afterthought to one of the core pieces of our functionality.

Yet, there are many differences. Large companies and startups both have their own set of advantages that play in their favor when executing ideas:

Large technology companies

• Resources: As the name says, large companies have tons of people. Once management is convinced of the viability of a project, they can put people, infrastructure, and money to work to make the idea become reality. Giants move slowly, but once they do, the earth starts shaking.
• Experienced management: In Silicon Valley, senior managers at large companies typically have startup experience. They started or joined small companies that got bought or went public. They know how to manage innovation and push interesting projects forward.
• Instant credibility: When Apple, Google, Microsoft, or Yahoo launches a new product, the world listens. If a startup had released Google’s phone SDK, there would not have been so much Google phone speculation in the press, weeks before the launch. Consumers will feel safe buying new Apple products when they’re launched, because they would know where to buy and what level of quality to expect. Startups have to build a really good product and build it from the start, build press relationships, and resort to guerilla marketing as needed.

Startups

• Focus, clear priorities: You’ll never see a company as focused on progress as a startup. At Xobni, the number one priority is to get high-quality software out the door. There’s only this one project: There are no distractions, no talks to attend, no other projects for engineers to switch to. We’re all sprinting towards a clear goal.
• Aligned incentives: At startups, employees have a significant amount of stock in the company, and their financial future is highly correlated with the success of the company. Thus, there is only one controlling variable: Their contribution to the product. If they can add or improve features, they will. On the other hand, large corporations attract resume stampers who are sometimes guided by self-interest: Their priority is to rise in the ranks, not contribute to overall success.
• No lockstep development: Startups have small numbers of people working on small products. Large companies work on large products with lots of people. These people require coordination and planning. For example, I’ve heard that the feature sets of Microsoft’s Office suite are planned out two releases in advance, with two years between each release. This means that a product manager on Word knows what features the product will have in 2011. If you’re an engineer at Microsoft and have an idea, it may not get executed upon until four years from now! In addition, there’s the burden of reverse compatibility: Every new feature must be compatible with versions of the software that are decades old.

In summary, we explored differences in how startups and large companies run innovation and product development. There are some commonalities – great people, focus on engineering, and good tools – but startups have large advantages because they are more focused and have no existing customers, products, and profit lines to look after.

Gabor Cselle is the VP Engineering at Xobni, an email software startup in San Francisco. Gabor received a Master’s degree in computer science from the Swiss Federal Institute of Technology in Zurich (ETHZ) for his thesis on “Organizing Email”. Prior to joining Xobni in March 2007, Gabor was a software engineer at Google Switzerland.

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By Flavio Rump, October 29th, 2007, Zurich

With the rising hype of Web 2.0 and it’s exponents like Facebook, Youtube et alia, the rumored valuation of those companies has also risen sharply. It is currently rumored that Facebook has reached a valuation of 10 - 15 bio USD with only 150 mio $ yearly revenues - not profit.

Facebook has only 300 employee’s and is not making a lot of revenue. If you compare to the also very hyped Google, making about 17 bio $ revenues a year and worth 200 bio USD, you find that with 100 times it’s revenue it’s worth just 15-20 times as much as Facebook. How can this huge valuation of 15 bio USD of Facebook be explained?

It is obvious that Facebook has gained a huge amount of traction, reaching almost everyone who is on the web. In a recent evaluation it was found that 22% of Canada’s population is currently on Facebook. These are more people for example than any Canadian political party has members.

A part of the valuation is certainly justified by the huge leverage you can create by having a fifth of a population in the same network. Think about polls, advertising, recruiting, government communication etc. You can now reach more people through facebook than through a newspaper or Television. Imagine Government sending out official documents to everyone that is in its country’s network.

All those opportunities create great revenue sources - and if combined with a potential of 200 to 300 mio users worldwide - can make one understand how much value could lie in this company.

A comparison with other US internet companies shows that facebook is already the 5th largest considering market cap, only surpassed by Google, Yahoo, Amazon and Ebay, all of them making 100 of millions if not billions in profit every year. Facebook’s 2007 net income is said to be around 30 mio USD, amounting to a P/E Ratio of 500 (Google’s P/E ratio is 50).

Facebook has been able to reach this valuation because of two main factors:

1. The idea that there is the need for only one social operating system and that facebook is the one

2. The bidding war between Google and Microsoft

The first factor, if true, allows to draw many conclusions on the potential of facebook. If it is going to be the Microsoft of the internet, the start page of every user and where every other company is going to build their application on top of facebook instead of creating their on website then yes, a valuation of this size does make sense.

Now I would suggest that the second factor has an almost greater importance. Google has made the right move against Microsoft many times: Search Engine, Gmail, Google Docs. Myspace ad deal, Youtube and others. The people in Redmond wanted to make sure that times they were the ones getting the right deal. And even if it would turn out to have been the wrong decision, 240 mio USD is likely to hurt Microsoft when they’re also getting the advertising deal with facebook that should generate substantial revenue over the next few years. It is also smart in terms of recruiter marketing, proving that Microsoft is serious about Web 2.0.

Certainly Microsoft has been willing to pay more for a stake in facebook than a traditional investor - that was not getting any extra deal with his investment - would have been. There have been rumors that two hedge funds have invested in facebook at the same valuation, though.

It will be interesting to see what happens when facebook goes public. Will the public enter the hype and drive the stock price into valuations even more exorbitant than the current?

Flavio Rump is currently an entrepreneur at bluepixel and a student of mechanical engineering at the Swiss Federal Institute of Technology in Zurich (ETHZ). In his personal blog he writes about social networks, politics and business issues mostly focussing on Switzerland. Flavio has also been a candidate in the election for the national council of Switzerland.

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