December 19, 2005

GP3 - Growth and Fraud - How to Book a Table

Previously, we talked about the Growth and Fraud's GP which is the place where growth kicks off into a self-sustained value growth machine (Parts 1,2) . Then I made some remarks on how to instruct security strategy, which lead to a rather keen need to know where this point is. That's because by the time we hit GP we really want to protect it, but not a moment earlier.

Where is GP? Obviously in a different place for every story. But there are some patterns. Assuming again that we are talking about a value system, we can predict the following indicators of GP by looking for the arisal of these factors:

  • An independant exchange network. That is, other companies without any especial permission from the lead company engaging in arbitrage and value exchange.

  • Delivered independant super-services such as plugins to popular clients. Think Eclipse, Skype, Firefox here.

  • New business models and/or activities by third parties that were not originally envisaged by the Founders. Note here that as a founder, you don't need to admit to the world that you didn't envisage a new model arising, but you do need to admit it to yourself.

  • Participants that founders don't know find other participants that founders don't know and ... trade! What this means is that no longer is the activity dependent on you, as founder, and your core network. You've exhausted your contacts, you've beaten up your relations, blackmailed your business partners and extorted your church. And it's still growing, with people you've never met and can't quite divine how they came to be in the system.
  • Fraud!

Noticeable among those is the absence of journalism, blog posts, coolness ratings, cute crypto features, show awards, recommendations by experts, endorsements, government regulation or permissions, what your mate thinks, etc etc. They all suck, in large part because they can all be bought, and are often negative indicators of GP, not positive ones. On the other hand what is present in all the above is:

  • Someone else's capital has been independently invested in the subsystem's potential,
  • that capital has delivered separate and persistent value exchanges,
  • and done so many times over to the extent that it is not an aberation, but more an economy.

These things cannot be bought. The importance is to see many independent events that indicate independent traders are putting their money where their mouths are, enough times such that it would take a major mistake on the part of original founders to break it now.

Thinking about fraudsters as investors might be confusing, but that's what they are at least as far as this analysis goes. Fraudsters invest their time and effort in a fraud, and some frauds pay off whereas others do not. Fraud is just a business where the more positive is the supply side, the more negative is the demand side.

Fraud is also a very good indicator of success. One reason for this is that fraud has a very short cycle of gratification. Unlike honest biz, most small frauds either pay off quickly or more generally not at all, so if you see a marked and noticeable incidence of fraud, that means the frauds are paying off. Thieves are very economically tuned, they move on to the next if this one isn't working, and stay and play if it is working.

Now that we've got a view that we can pick GP, what do we do about it? The previous section talked at length about security, so if it hasn't twigged by now, we start by ramping up our anti-fraud efforts. As we've included fraud on the list above, we are hopefully staring at the first efforts of fraudsters, so we should actually have some good, market driven data on what fraud matters and what is just crypto blah blah security hype.

The next thing we have to worry about is ... the whole business. Before GP we had not proven the model. After GP, we have, and this apocalypse changes our entire strategy. Before GP we were doing everything possible to push the model, but we had no real reason to keep it. After GP we switch to doing everything possible to preserve the business and user base without overly slowing down the model.

The switch is subtle, but it has quite dramatic connotations. Firstly, we now know where to spend money. So GP is the time to go for the big Venture Capital round! In fact, I'd say that the question to be asked at the VC meeting is "how do you know you've reached GP?" Anything before GP is seed money, as it is simply experimental funding to try out different ideas and different models.

Then, when we get the money, we know where to spend it: supporting the model. Extending it, expanding it, adding to it, and very important for those security guys that are still with us: protecting it.

Finally, this takes a very different mindset. This means a new team - in general, from a Human Resources perspective, most entrepreneurs don't cross over well from the mad chaos of pre-GP to the mindless protectionism of post-GP.

It's probably not wise to announce GP on your own. That might be tempting fate as those deep inside their own business have a tendency to migrate their beliefs to suit their desires, and I don't want to be blamed for them getting it wrong. At some point the market - your strong and critical fans especially - will agree one day that GP is passed. At that point these same critical fans will be strongly looking for signs of management team change, security overhaul, and serious understanding of the revenue and finance model.

They'll also be looking for people who have a bit more of a wider view than your average security geek, accountant or salesman with a great idea! And it is breadth to which we turn in our final installment (of 3 parts), in an attempt to show how relevant this concept is.

This is Part 3 of Growth and Fraud:

Posted by iang at December 19, 2005 09:12 AM | TrackBack

Some observations/questions: Take the example of Napster. The service was set up in a dorm room. When did Napster reach its GP? I would say, it was self-sustaining from day one. It was immediately worth joining and investing in (by installing a client and sharing one's own collection).

Posted by: Daniel A, Nagy at December 21, 2005 08:53 AM

Napster is an interesting case. I would say that it is hard to unravel it as on one reading, the entire model was fraud - "stealing IP" - and on another reading, it never ever entered any economic systems space because it never ever generated and released any monetary value. So, as there was never any monetary value, there was never any economic calculation, and thus it never achieved sustainability on its own merits. E.g., it collapsed when faced with the obvious attacks.

Systems like Mojo Nation moved to bring economic calculation back into the business cycle. Systems like BitTorrent moved to take the usage model out of the business cycle (by being code / service only). Both and all other followers responded to the failure of sustainability of the original.

Of course, these observations are contradictory ;-) It is an interesting case...

Posted by: Iang at March 26, 2006 09:43 AM
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