Breakpoint_Why the Web will Implode, Search will be Obsolete, and Everything Else you Need to Know about Technology is in Your Brain

by Jeff Stibel

  Joining a crowdfunding community, such as Kiva, Indiegogo, StartSomeGood or Kickstarter, fulfills the desire to give as well as the desire to get involved. President Obama used this to his advantage and leveraged social media and his own crowdfunding website to empower his supporters to donate and participate, and pundits including New York Times journalist David Carr even credit that as one of the defining movements that sent Obama to the White House.

  It’s no surprise that crowdfunding is in hypergrowth despite being a young technology. The 130 existing crowdfunding platforms in the United States raised nearly $3 billion in 2012, almost double the amount they raised the year before. All crowdfunding falls into one of four categories: donation-based, reward-based, lending-based, and equity-based. Donation-based platforms, such as the one used by President Obama, allow people to donate directly to a person or group in need, connect with others who also support the cause, and in many cases receive updates detailing exactly how their money is helping. Reward-based platforms are a slightly different format, often used by independent artists and writers as well as start-up technology companies. They ask contributors to donate money in exchange for some type of good or service. For example, in 2012, musician Amanda Palmer used Kickstarter to raise $1 million to fund her new record. For their contributions, her supporters received a copy of the CD, signed posters, even an in-person meeting. This model is like a presale without the store. An up-front payout enables recording artists and authors to bypass the record label or the publishing house.

  Lending-based platforms such as Kiva focus on microloans to small businesses in developing countries; others such as Lending Club enable small-scale investors to lend money to people seeking loans to buy cars, make home improvements, or even plan weddings. Lenders make small loans and group together for bigger amounts. Need $10,000? It may come from 300 people and be facilitated by Lending Club. Lenders receive a healthy return per year and the feeling that they’re doing something good; borrowers get to avoid traditional banks and handle the entire transaction in a hassle-free online process. These types of loans are now commonly called microfinancing.

  The most controversial type of crowdfunding is equity based, which became legal in the United States when President Obama signed the 2012 JOBS Act. I suspect we’ll see hypergrowth in equity-based funding in the next few years, but this type of crowdsourcing is not without its risks. Hyped as a way to make money fast, equity-based crowdfunding enables just about anyone to invest money in exchange for equity. The advantages of this approach are that it truly democratizes investing in private companies and also makes it easier for new businesses to raise money. The risk is that novice investors could easily become disillusioned when their first few investments tank and they’re faced with the reality that becoming Warren Buffet isn’t easy. In fact, we’ve already seen this happening on a smaller scale with Kickstarter projects, where people donate money to companies with the expectation that they will receive a product. CNN found that 84 percent of the site’s top projects shipped late, if at all. Kickstarter is trying to combat the impression that the goal of the investment is simply to receive a product. In a 2012 blog post entitled “Kickstarter Is Not a Store,” the company’s management explained that “it’s hard to know how many people feel like they’re shopping at a store when they’re backing projects on Kickstarter, but we want to make sure that it’s no one.” So much for the customer always being right. No matter how emphatically stated, Kickstarter’s message is a difficult sell. There is little doubt that the nearly 70,000 people who collectively handed over $10.2 million in 2012 for a Pebble Watch, for example, expect to actually receive a watch.

  One has to wonder if this type of crowdsourcing is a fun trend, is something for the in-crowd to brag about at dinner parties, or has legs to survive long term. Crowdfunding companies are growing exponentially quarter after quarter, and by all measures, the industry is still in its infancy. At some point, it too will hit a breakpoint.

  VI

  What a piece of work is a man, how noble in reason, how infinite in faculties, in form and moving how express and admirable, in action how like an angel, in apprehension how like a god: the beauty of the world, the paragon of animals—and yet, to me, what is this quintessence of dust?

  We would never expect the words of Hamlet to come from a crowd. But scientists have been arguing since the early nineteenth century whether this might be possible. Put enough monkeys in a room with enough typewriters, the argument goes, and eventually they will produce all the works of Shakespeare.

  In April 2012, Time magazine shared the story of The Collabowriters, a website that was facilitating the writing of the first crowdsourced novel. Anyone can submit his or her idea for the next sentence, and the crowd votes the entries up or down. Once an entry receives enough votes, it becomes part of the novel and the crowd moves to the next sentence. Certainly an interesting concept, but as of early 2013, the novel had only been completed up to page five. In comparison, novelist Stephen King writes five to ten pages per day. Time described the novel as “jumpy . . . in a kids-telling-stories-around-a-campfire sort of way.” Perhaps crowds have intelligence, but it would seem that literary brilliance is still the domain of individual authors. For now at least, one Shakespeare, even one King, is much better than a thousand crowded poets.

  Eight

  Squirts | Profit | Traffic

  The first and most important life task of a sea squirt is to find a place to live. These small marine creatures, closely related to hagfish and lampreys, swim around the ocean and weigh the pros and cons of various pieces of real estate. Bits of the seafloor, underwater rocks, and sometimes even the hulls of boats are considered.

  When a sea squirt finds the perfect spot, he attaches himself, and it becomes his permanent home. For the rest of his life, the sea squirt will live in this one spot and perform one function: filter in water, remove the plankton to use as food, and filter out what’s left. It’s automatic, like breathing, and requires little brainpower. Having found a good rock, the sea squirt finds he is no longer in need of the brain that helped him find a home, so he eats it! In doing so, he reduces his energy demands. He’ll require far fewer calories in the future than he would have otherwise. Pretty smart.

  Consuming his brain works pretty well for the little squirt and his friends: sea squirts have been around since the beginning of the Cambrian period, over 500 million years ago. Every animal’s main goal is long-term survival, and like sea squirts, many creatures have evolved unique tricks for that purpose. Wood frogs freeze almost half their bodies and temporarily pause the beating of their hearts when it’s too cold to function. Certain carpenter ants, when faced with a serious foe, will squeeze his or her own body until it explodes, unleashing a toxin on the enemy. The ant dies, but in murdering an enemy, it selflessly saves the rest of the colony from that particular threat. The goal of any species, whether frogs, ant colonies, or sea squirts, is to survive as long as possible at any cost.

  I

  All of an animal’s traits, tools, tricks, and so-called advantages are there only to help the species achieve nature’s ultimate goal: survival. For our part, humans are almost the opposite of sea squirts: our most unique survival tool is our superior intelligence. We can’t run fast like cheetahs; we don’t have forceful jaws like crocodiles; our skin isn’t camouflaged like that of stonefish or flounder. The one competitive advantage we have is our big brains. Like all animals, the goal of humans is also to survive, and our brains help us do this.

  There is an important life lesson within biology: know the end game before you set out on your journey. Enamored with our own intelligence, it is easy for us to forget that if it is not useful for survival, nature will phase it out. The process of evolution eliminates traits when they are costly but not useful: humans lost significant body mass to allow more energy to flow to our brains; turtles lost large spikes on their necks to allow them to
retreat into their shells; sharks lost the heavy bone structure of fish in favor of more efficient cartilage.

  We have focused up to this point on the phases of networks: how they grow, what happens when they reach breakpoint, and how to keep them from collapsing and enable equilibrium. But more fundamentally, networks seek survival. In fact, this is the only goal of a biological network. When we consider networks run by businesses, however, survival is only one side of the equation. The other is making money. The problem is that these two goals are often at odds.

  Businesses are sometimes focused on making money at the wrong time, and it costs them in terms of network growth. Other times, businesses are far too consumed with network growth, and they overshoot to the point of collapse. While growth is critical to a network, it is not an end goal. And while money is critical to any business, it too must sometimes retreat behind the greater goal of survival.

  In the first network phase, growth should be pursued at the expense of everything else. The reason is simple: if you don’t capture all of the carrying capacity in an environment, someone else will. However, as we’ve seen, when the network hits a breakpoint, growth should be allowed to slow, and occasionally a forced slowing may be needed. After breakpoint, continued growth will be counterproductive and will cause a network to exceed its carrying capacity.

  As a network reaches equilibrium during the final phase, the real rewards start to come in. Equilibrium makes longevity easier—the network is stable, fully scaled, and healthy. But more than that, stable networks can be exploited, and there are many ways to profit from them. It is worth spending some time on each of these stages to explore how they can be managed successfully by businesses.

  II

  There isn’t much that hasn’t been said about the growth phase of technological networks. It has been one of the most popular themes for technology books, has become legendary in stories and movies about internet mavens, and has led to untold riches for countless twenty-somethings. Of course, the one missing component in most of these anecdotes is that growth always comes to an end eventually.

  Despite the spectacular success of some, the truth remains that most networks (and businesses) die during their growth phase. They simply don’t grow enough: they don’t catch on, they don’t reach hypergrowth, or they don’t grow to fill all available carrying capacity. They don’t claim their big rock, and this enables competitors to swoop in.

  The most successful networks are allowed to grow unencumbered during their growth phase. As we know, networks must have large numbers. Consider that the first telephone was utterly useless. The second phone was slightly more useful, but only to communicate with the first. It took thousands of telephones before purchasing one made sense, and millions more before the telephone became truly indispensable. So it is with any new network. It must grow, and grow, and grow.

  Those who run networks should remove all barriers during the growth phase. The object of a business during this time is to gain as many users, as much content, as much lichen, as much of anything that the network needs to thrive and grow. Anything that may create a barrier to growth should be removed. Salaries and costs should be kept low; speeds should be optimized; simplicity is preferable to depth.

  By far the largest barrier to growth is money. In keeping with the basic economic theory of demand, charging money shrinks growth. Demand for a product or service goes down as the price goes up. To encourage high demand, prices must be kept low. For the majority of internet networks, it’s not enough for the price to be low: it must be free.

  Free is the golden rule for pricing during growth. Studies by economists such as Duke University’s Dan Ariely have shown that people do not behave rationally when things are offered for free. Among other things, Ariely demonstrated that the difference between free and a penny is often psychologically greater than the difference between $.99 and $1.00, and that affects purchasing behavior. You would think the average smartphone or tablet user wouldn’t hesitate to spend money on an app. But a 2012 Cambridge University study found that free apps are 100 times more likely than paid apps to be downloaded more than 10,000 times, despite the fact that the average price of a paid app is only $.99. In fact, only 20 percent of paid apps are downloaded more than 100 times. When something is free, consumers are willing to try it more often and be far less critical.

  All of this begs the question of how a company gives away the store and still survives. Two factors are at work here. First, when a person joins an online network, the added cost is often insignificant. My joining Instagram, for example, doesn’t cost Instagram anything. Software is especially well suited to being free; once the software is developed, the cost of providing it to additional people is nil. This gives software companies an opportunity that other companies don’t have: Ferrari wouldn’t survive very long if it started giving away sports cars.

  The second factor is venture capital funding. Venture capitalists, no strangers to risk, are often willing to subsidize a company in the short run in hopes of big returns later. In Silicon Valley, many start-up networks attract venture capitalist funding in their hypergrowth phases whether or not the company is generating revenue. Venture capital lives and thrives in the growth phase. Venture money often acts as a subsidy so that consumers don’t have to pay for products early in their life cycle. Think of the last time you paid for Twitter, Facebook, LinkedIn, Google, Yahoo!, or any other online service. In the early days, none of these companies made any money; their sole purpose was to satisfy customers and increase their user bases. Money came instead from venture capitalists hoping to reap the long-term rewards of a thriving network.

  The odds of succeeding in venture capital are extremely low. That shouldn’t surprise anyone given that the odds of success for anything in the growth phase are low—most species and businesses never make it through this period. The best venture firms have a success rate of only 30 percent; the average is below 10 percent. But in many cases, that is enough. A single start-up that makes it through the breakpoint can fuel the success of an entire venture fund. Over 90 percent of companies die during this phase, but venture capitalists thrive on the remaining crop.

  Regardless of how much money you can raise, giving your product away for free is counterintuitive to business. It’s no wonder that the best network builders of the internet age have been kids: Mark Zuckerberg started Facebook while in college, as did Sergey Brin and Larry Page with Google, and David Filo and Jerry Yang with Yahoo!. With few obligations, kids are willing to work long hours and risk what little they have for long-term potential. Without experience, the absence of revenue doesn’t seem so bad. With the reality of an enormous failure rate, younger people also have the benefit of time: they can pick themselves up and try again until they make it.

  Sometimes you have no choice but to charge, as is generally the case with physical goods. But even in those cases, it pays to subsidize and sometimes even to lose money. This was true of the early days of almost all the e-commerce giants, from Amazon to Zappos to Netflix. They raised venture capital and used that money to pay their bills while the companies were still unprofitable. E-commerce is still subsidized today, with free shipping and no sales tax in many cases.

  Companies that charge too quickly inevitably fail in the long run. AOL charged for internet access right at the start, which allowed room for the free ISPs that nibbled away at AOL’s dominance. Consider Peapod, which launched the first grocery delivery network in 1989. In the early days, they charged a hefty sum. While they grew quickly, they failed to make it through the breakpoint. By the mid-1990s, during the heyday of the internet boom, new competitors such as Kosmo and Webvan were taking advantage of this, raising hundreds of millions in venture funding. These competitors quickly overtook Peapod with a more attractive offer: free delivery.

  Webvan became a bona fide Wall Street darling; it went public with a mere $15 million in revenues but received an astronom
ical $8 billion valuation only months later. On the other hand, Peapod had lost its allure. Morningstar reported that “investors hate Peapod stock as much as children loathe broccoli.” Peapod responded by matching the free delivery offer, but it was too late. Its competitors had secured a commanding position.

  Luckily for Peapod, the dot-com crash of 2000 took funding away from its competitors. That allowed Peapod to inch its way back in and learn from its mistakes. Once it dominated the network, Peapod was able to charge again, and the company announced that intention in 2001, weeks after their competitors went bankrupt. Peapod is now the lone standing grocery delivery service at scale. But even today, Peapod’s model includes a free component—they will do your shopping and bag up your selected groceries free if you come to the store to pick up the order. Only if you want your order delivered do they charge a fee.

  This “freemium” model has become very popular. The idea is that a company creates two classes of product, a free version and a premium version. It can be a great strategy during the growth phase, but even freemium poses a risk if competitors come knocking too early. Netscape employed this strategy in the 1990s by offering its browser free for noncommercial use but charging corporate clients. That worked for a while with limited competition, but Microsoft eventually destroyed Netscape. Microsoft borrowed from the venture capital playbook and introduced its 100 percent free Internet Explorer. Then it further fueled growth by bundling the browser into almost every personal computer on the planet.

  Microsoft is a rare example of an established company stealing customers from a venture start-up in a new market during the growth phase. More often than not, larger companies are hamstrung by their own success. Imagine being in the position where your company is making millions and you’re faced with the opportunity of giving that money away to potentially win a new market. Most leaders aren’t bold enough to take on that challenge, so they retrench and attempt to maintain their market position. For an individual CEO, that might be the right move. It ensures profits and reduces short-term risk. But over the long run, lack of innovation often leaves companies in a state of peril (of course, by that time the CEO is retired). This is one reason that even large companies rarely survive past 50 years or so.