Value the Silicon Alley Way
Although the firm has a heavy presence in the Alley and invests exclusively in Internet related companies; Flatiron's investment reach and strategy are not glued to specific regions or sectors. Flatiron is perhaps best known for its lucrative investment initiatives into content/media, International, and "pervasive computing."
Public partner companies to date include: StarMedia (STRM), TheStreet.com (TSCM), and iXL (IIXL). Exciting private company investments include The Industry Standard and Kozmo.com.
Looking to get more insight on Internet investing and venture capital success, I recently took a cab ride to Flatiron Partner's offices at 257 Park Avenue South in New York City. As I entered the heart of Silicon Alley, I couldn't help but notice the billboards and painted buildings advertising, what else, Internet companies. Once inside I had the opportunity to sit down and speak with Jerry Colonna.
Reporter@Large: At what stage in the start-up's development is Flatiron really looking to invest?
Colonna: We're on our third fund now and it's a $500 million commitment from Chase Capital. As a $500 million fund, the size of investment that we're looking at has shifted somewhat. Up until 1999, our sweet spot was really $3.5 to $5.5 million as a first time investment. Over the last year, when we completed 26 new investments -- which is a record for us -- we did as small as $l.5 million and as much as $l5-20 million. Right now, I would say that the average investment--immediate investment--is more like $8-l0 million. And that's a result of how much capital we have to put out. Everybody's feeling the need to put more capital out.
Reporter@Large: I want to get into Flatiron's focus areas within the Internet space in terms of content, commerce, and communications. These areas seem so broadly defined.
Colonna: Yeah, that's really marketing language. The areas that we see ourselves in are online media, International, and pervasive computing. These are three areas of expertise that we have.
Reporter@Large: You have certainly attracted a lot of attention with your online media focus.
Colonna: Within the online media sector, we are very much interested in manifestations of my theory. My theory goes like this: The value of a media property grows in relation to the level of affinity that the audience feels for that property. Moreover, the value of the property actually increases over time, unlike, say, the value of a product, which starts to die out unless you constantly create new versions of the product. Media properties have a much different life cycle.
Reporter@Large: So Yahoo! for example. I use Yahoo Finance.
Colonna: Yahoo Finance as a product probably generates $50-$60 million in revenue at minimum. Well, that's a nice, healthy little profit there. You can take Yahoo Finance public. Yahoo is a good example because they've done a very good job of developing tools to strengthen the affinity between the audience and the company. And so, Yahoo Messenger, Yahoo Companion, the paging tools, the instant messaging tools, tickers and that sort of thing--these are all applications that we like to call stickiness--but it's really not about me spending three hours, it's about me investing my time and developing an affinity for your product and staying with it. There's lots of ways to develop an affinity. Do you remember the TV show, MASH?
Reporter@Large: Sure.
Colonna: Think about the last episode of MASH. People are sitting around in bars, hugging each other, laughing, and crying. Well the irony is that the product's greatest moment of affinity was actually its last episode. And what happened? The value of that property increased over time. And what happened was that if you were to buy 30 seconds of advertising on the first episode of MASH vs. the last episode of MASH, which would you pay more for? The last episode.
Reporter@Large: So while a Draper Fisher Jurvetson eyes investments that have a "viral" spark, Flatiron is looking for affinity.
Colonna: Right. Now, we talk about targetability. We talk about taking that affinity to the next level. Saying ok, you want to reach baldheaded doctors who scuba dive. Well, we can find them for you, right? Because you've got a Rogaine product that doesn't wear off in water. And you want to sell this product to these people. That's the promise of Internet advertising. It's merely to take that level of affinity one step beyond and create targetability based on the affinity. The strategy is in fact to invest in products that have a high potential for affinity between their audience and the property. So, if you look at The Industry Standard--how often do you read the Standard even though it's 350 pages a week? You read it every week. You read it religiously. If you're a member of the Internet community, you have to read the Industry Standard. That degree of affinity--they've been very successful in monetizing and turning it into an extraordinary revenue stream in a relatively short amount of time. Well, that value--that power--if we can replicate that power in a lot of different areas--that's the theory behind all our investments--it's all about reaching a particular audience, with a particular set of products, that have a high degree of affinity.
Reporter@Large: So with affinity, we're talking about a number of things--services, applications, people...
Colonna: Exactly. Affinity is not the application. The application is the manifestation of the tools that drive affinity. The goal is affinity. Again, think of that MASH episode. That last episode was a gold mine. And in fact, it may have cost them more than the first episode, but it was not proportionately the same level as the amount of money that they made. That's the thing to think about. The last episode of Seinfeld vs. the first episode. Lucy giving birth to little Ricky.
Reporter@Large: Let's say there's an Internet executive answering questions at E*Trade's Web site. Is E*Trade able to charge higher CPM rates for that particular period of time? Are we seeing that?
Colonna: One of the challenges right now is that there's a perception that all information is equivalent on the Internet. And so therefore information becomes a commodity. And whether you can charge for that information or not is a different question. The theory is it's more valuable. If you start with the notion--let's agree for the moment that the higher the affinity, the greater the value. The question is who pays for that value? Do you pay at higher CPMs? Because remember, media properties have two constituents--advertisers and the audience. So who pays for that value? The audience or media companies? If you can increase the CPM, theoretically, you should lower the price. I'll give you an example. I come from a trade publication background. The CPMs at Information Week are higher than the CPMs at the Wall Street Journal. Which publication is more valuable? Does it matter? Which publication is more profitable on a percentage basis? Ah ha--interesting question. How much do you pay for Information Week? Zero. How much do you as an audience member pay for the Wall Street Journal? $l50 per year. Which is more valuable? Value by itself is not the right question. It's profitability, it's return on investment. If it costs $700 to acquire a subscriber and the lifetime value of that subscriber is $900, you're making money. If it's $400, it's a shitty business. Those are the metrics that you've got to look at. These are all applicable to retail as well. These are all applicable to other services that are purely Web based and Web delivered. This is the same issue. The only difference is you don't have the sort of duality in the constituency. You don't have the ability to say, well, I'm not going to charge you, I'm going to charge you.
Reporter@Large: So Buy.com, sell below cost and try to make money on advertising.
Colonna: Right. Try to create a duality in the constituency to create affinity. I'm going to be here, this is really valuable because I can buy this for less than the price here. Create a high degree of affinity and at the same time drive up the value. So, theoretically, they won't be able to get very high CPMs because they don't have any control of the demographic--they can't say you but not you--but they'll get large volume. It's the same model as a newspaper.
Reporter@Large: One of the issues on my mind is the lack of services from an Earthlink in providing a hub and community similar to what AOL does for its users. It's obviously important for media companies to control access and content at this point. Perhaps a merger between Earthlink and Lycos makes sense.
Colonna: That would be an interesting move. I have no information but that would be a really interesting move. I think that there are a lot of complexities between here and there, but yeah, it could work.
Reporter@Large: I know some of your partner companies have a relationship with 1stUp.com (a company that provides Web sites the ability to offer its users co-branded, free Internet access). Seems like a promising model.
Colonna: I think that the 1stUp model makes sense. If your value proposition is to sell a low margin commodity product like free Internet access, then piggybacking off of someone else's investment in affinity makes a lot more sense. And so one can envision 1stUp doing a deal with the NY Yankees which is my favorite example of a high degree of affinity because I'm a die-hard fan. Why wouldn't the Yankees offer fans free access? I mean, wouldn't you sign up? In a heartbeat!
Reporter@Large: Well, I'd take the Mets, but... (laughs)
Colonna: But would you do it for the Mets? Take the email address: Luke@Mets.com.
Reporter@Large: In a heartbeat.
Colonna: And could they then pick your demographic and hit you with a ton of ads? Sure. You wouldn't mind. Because in the back of your mind, you've already made that leap. You're now a part of the Mets organization. Nuts--you're not. All they're doing is taking a brand and it's like putting it on a VISA card.
Reporter@Large: So all of these analysts out there right now saying content is king, content is king. It's more about affinity than about content.
Colonna: You're absolutely right. It's about affinity. It's not about content. Content leads to affinity. Content that fails leads to no affinity. Think of the dozens and dozens and dozens of people who watch Beverly Hills 90210 every week, even though they know it's pretty poor content. If you merely say content is king, then you think that some PBS show with high, high quality is gonna drive it. That's not enough. People have an affinity. There are all sorts of reasons why people develop affinity.Ithink that the number one reason people develop affinity with content is people.
Reporter@Large: What about the last mile of e-commerce and one of your partner companies, Kozmo.com?
Colonna: I think for a high percentage of goods, the last mile becomes the most important mile. Who cares if you can get vitamins for 50% off if you need them now? Who cares if your drugstore.com, that you can offer aspirin for 50% off if I need it right now? If you step out of a replenishment model, where people can think about and predict when you're going to run out of a product, this is about the most important development in e-commerce. Kozmo is one manifestation of that. There's a much bigger issue here. The bigger issue is how--we've gotten convenience to such a point that in a household like we have at home, we have cable access, we have 3 PCs, they're always connected, everything's always on, it's easy. It's very easy. In fact, it's easier to buy online than to buy offline. But the biggest problem is I need it now. I need a gift. My son walks in and says I have a birthday party this afternoon. How do I get that? Until Fed-Ex gets to the point that they can deliver on the last mile of e-commerce within hours, that will knock the dream of commerce being fully enabled. We'll always be stuck. Sort of like our product on the conveyor belt in a distribution center in Memphis with the Fed-Ex package.
Reporter@Large: I know you've invested in LivePrint.com...
Colonna: Did you hear the announcement?
Reporter@Large: No, I didn't.
Colonna: We sold it. We merged LivePrint into Kinkos.com, the Web subsidiary of Kinkos, a few days ago.
Reporter@Large: I was interested because I see iPrint.com is going public (iPrint has since gone public, IPRT). I thought maybe that Flatiron had missed the boat.
Colonna: Never count us out.
Reporter@Large: We won't! Thanks for taking the time to speak with us Jerry,
Colonna: Thank you. Have a great day.
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