Value the Silicon Alley Way

As one of the top venture capital firms in the Internet universe,
Flatiron Partners is also recognized as the premier VC firm in Silicon
Alley. Flatiron was created in 1996 by managing partners, Jerry Colonna
and Fred Wilson, and is located in New York’s historic Flatiron
district.

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.

[email protected]: 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.

[email protected]: 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.

[email protected]: 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.

[email protected]: 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?

[email protected]: 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.

[email protected]: 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.

[email protected]: 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.

[email protected]: 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
publica

tion 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.

[email protected]: 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.

[email protected]: 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.

[email protected]: 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!

[email protected]: Well, I’d take the Mets, but… (laughs)

Colonna: But would you do it for the Mets? Take the email
address: [email protected]

[email protected]: 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.

[email protected]: 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.I

think that the number one reason people
develop affinity with content is people.

[email protected]: 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.

[email protected]: I know you’ve invested in LivePrint.com…

Colonna: Did you hear the announcement?

[email protected]: No, I didn’t.

Colonna: We sold it. We merged LivePrint into Kinkos.com, the Web
subsidiary of Kinkos, a few days ago.

[email protected]: 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.

[email protected]: We won’t! Thanks for taking the time to speak
with us Jerry,

Colonna: Thank you. Have a great day.

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