MattMaroon.com

There’s been a lot of discussion lately about whether or not we’re in a yet another tech bubble. It’s a complicated question because what exactly is a bubble? Clearly we all agree it involves “irrational exuberance” but to what degree?

Mark Cuban says it’s not a bubble, it’s a pyramid scheme. I think his logic is flawed. It assumes that later investors are paying back the former, which is quite atypical. Most of the action these days is coming from seed and angel investors, who rarely get paid anything before an IPO or acquisition. If anything, convincing later investors to follow on only increases an early angel’s variance, as it raises the figure needed for an acquisition. The public markets, I think, aren’t going to be as easily fooled as last time around and I don’t think anyone’s counting on them being the suckers at the bottom of a pyramid.

Currently there isn’t much bubble-like activity in the public markets. In the first go around I was asked questions like “I just bought 1,000 shares of Cisco, what do they do?”. Back then anything even remotely computer-related had a stratospheric P/E ratio. Most publicly traded tech stocks are trading at reasonable levels now. Even Apple is at 20, compared to an S&P 500 average of 24. There are a couple exceptions (most notably Netflix) but on the whole tech stocks are not out of line with what we’re seeing in other industries.

There are a few big differences this time around. For one there are real revenues and even profits. Groupon will likely top $1 billion this year, and their margins are probably pretty high. Facebook’s may have topped $1 billion last year already. Zynga is pulling in somewhere in the 9 digits. Last time the problem wasn’t that people were giving a company a $50 billion valuation despite it only having $1 billion in revenue, it was that they were giving a multibillion dollar valuation to a company that might not even have a feasible business model. When it comes to P/E ratios, there’s a huge difference between fifty and infinity. Fifty means the company has a proven revenue stream and a high chance of increasing profits through improving operations or scale. Infinity means they might be trying to sell something nobody wants.

I have no doubt that startup valuations are overly high. It’s just to good of a fundraising climate for founders. Even though Y Combinator alone is pumping out 80+ startups a year, the relatively low capital needs have too many investors chasing after two few startups. Even if you assume there are another 80 startups worth funding in the valley every year (and we’re at the point where I’m not sure that’s a safe assumption anymore, at least at the angel level) that’s still not that many opportunities to do an early deal with a team of founders.

So what’s going to happen in the long term? Well, I expect investors are going to see a lot of middling returns. This time around companies, with a few exceptions, aren’t going to crash and burn like last. Even Twitter will probably find a way to make decent revenue. The amount of money that can be made selling ads alone is now substantial thanks to targeting. During the original bubble products like AdSense and virtual goods and freemium services weren’t yet widely understood, and if they had been I think we would have at least seen fewer wipeouts. People know a lot more about making money on the net now than they did a decade ago and that will help a lot when the inevitable correction comes.

Paul Graham wrote an article not too far back called What Startups Are Really Like that mentioned a number of things the people he had funded were surprised to learn over the years. Lots of good stuff there, and I wholeheartedly agree with most. (Especially #12, It’s Hard to Get Users. You grow up hearing that if you build a better mousetrap, the world will beat a path to your door. That, it turns out, is sadly untrue, as the fact that Apple spending a few hundred million dollars a year marketing the iPod proves empirically. In fact I think that if I were running one of the many startup funding groups using Y Combinator’s model, I’d start by putting together a team of people with experience in user acquisition to run it. That would be about the only way to compete.)

I’ve recently come to realize there’s one thing I’d add to the list, which is that a startup is hard when it’s not yet succeeding (either because it’s too early or it’s just struggling) and then once you start doing well, it gets even harder. That’s unintuitive I think, and if you’d have told me that when my startup was struggling I might not have believed it. The hard part is transitioning.

When you first start off, it’s you and one or two other people and you’re doing everything. All of the high-level work. All of the grunt work. Everything in between. You’re a lawyer, accountant, designer, programmer, customer support person, and whatever else you need that day. You hopefully communicate well with your cofounders in order to divide up labor, and then you each go out and do everything that needs to be done because there isn’t anyone else to do it.

However if you think about Google, you’ll realize quickly that Larry and Sergey aren’t doing that. I’m not sure what exactly they do (though I’ll bet they do a lot of whatever it is) but you can be pretty sure they aren’t trying to tweak the colors on the main page or iterate the Page Rank algorithm anymore. In fact even at a startup of 50 people, that’s clearly not going to fly.

So among software companies that succeed, the founders probably start off doing one thing and end up doing something else. I can’t say for sure what the end-point is like because I haven’t gotten there yet, though I promise to share if I do. But I can tell you what comes in that transitional period right after the early stages and it’s pretty hard.

At first you’re working part-time on hiring (probably a totally new skill set for you) and the rest of the time you’re still getting things done. Then you hire a couple people, and you’re working on hiring, getting things done, and managing the people you hired (another new skill set, and one that often does not come easily to people who get things done well themselves) to make sure they’re not only getting things done, and done well, but getting the most things done well that they possibly can.

That in and of itself, when it comes to programming, business, and other mainly mental tasks, is a chore so onerous that many books have been written about it. In fact large businesses have multiple layers of people in their org chart dedicated entirely to that, but you’ve got to do that yourself and hire new people (because the work keeps on piling up) and keep the servers running, all at the same time.

So you keep on trying to juggle the three but you realize more and more that you just can’t do it. One or two of them get done well, and one or two of them get totally neglected, and its almost certainly the new and hard tasks like management that get pushed to the side.

Then maybe you wake up one day to find that when you were hiring, you hired people who didn’t have the same skill sets as you because you were hiring them to compliment you. You were figuring you’d keep doing what you’d been doing, and they’d do these other new tasks. But now you really can’t do what you’ve done for the last couple years because you have other responsibilities and you need new people to step up and do what you did, and you maybe don’t have them because that wasn’t what you were hiring for.

Even if not though, you’re still in a pretty tough spot because your natural inclination is to minimize the other crap and keep getting things done. That’s what got you where you are, and you’re in a good place, so you tend to keep on doing it. You’ve spent months or maybe even years doing what needed to be done when it needed to be done but now you’ve got to not only trust the people you hired (the end results of the hiring process you totally pulled out of your ass because you had no experience hiring and maybe even had no experience being hired before) to get things done when needed, but also monitor how they do it and help them do it better.

The next step, which is where we’re getting to now, is where you transition entirely to managing and hiring, and your employees get everything done. This is a letting go process, I imagine, much like sending your kids off to college, except in this case if your kids party too much and fail Calc II you just lost the business you spent years building. In business, though, you adopted your children and can send them right back to the shelter at any point, so its your fault if they do not succeed, which doesn’t make it easier when you’re nervously trying to determine whether or not to write up that job offer letter or can the employee who might be underperforming.

And then after that I suppose you’re hiring and promoting other people to do the hiring and promoting, and focusing on higher-level stuff. And after that I guess you’re sitting next to your Gulfstream V on a beach acquiring a taste for Mai Tais or something, who knows.

But during the ugly duckling phase, where you’re not quite a General yet but not quite a Private First Class anymore, transitioning is extremely tough. It’s a great problem to have, but it’s perhaps the most stressful thing you’ll deal with in the early life of a startup.

TechCrunch wrote an article this weekend entitled Scamville: The Social Gaming Ecosystem of Hell that’s stirred up a lot of controversy, and even some changes, in the social gaming industry. This is an area I know a little something about so I thought I’d comment.

Arrington’s not entirely off-base here, but he’s not entirely on either. For one, he’s probably off by an order of magnitude as to how much of the money flowing through these platforms comes from scams. In our time running games, we’ve generally seen direct payments make up somewhere between 50-60% of total revenues. That’s counting banner ads (which are low, maybe 5%) and offers. This is pretty typical from what I’ve gathered in talking to other developers.

Of the offers, most of the money comes in from the legitimate pay ones like Netflix and Blockbuster (the two biggest), Free Credit Reports, Credit Cards, DirectTV, Gamefly, etc. Customers may be scamming those a bit, but that will just cause them to reduce payouts a proportional amount, ensuring developers get paid about the same regardless.

And then of the free offers, many are legitimate, albeit very low-paying. There definitely are some that will get you on the hook for $10 per month on your cell-phone bill if you’re not careful, but there aren’t that many of them and they haven’t paid out excessively well for months now, so as an overall percentage of platform revenues they’re not very significant. Trust me, there aren’t many offers me and my coworkers have not tried, and only once has one of us fallen for that. I’ve seen a couple pop up myself but was smart enough not to receive a code in a text message and then type it in, or to give a real phone number.

Mike also seems to be confused about who does what in the whole ecosystem. He says “Game developers, desperate to monetize, then search for ever more questionable offers to make up the difference.” Game developers don’t ever search out offers as far as I know. Rumor has it that one big developer is testing their own offer platform, but that’s the only case of it I’ve heard of.

Offer providers search for new and better offers, game developers simply display an iframe. And offer providers, like any sane business, don’t look to replace revenue, they look to maximize. They’re not like “hey Netflix dropped from $25 CPA to $20 CPA, we better find something scammy that’s $25.” They simply look for what pays the most and put that at the top at all times. It’s a state-based effect, and having Netflix’s rate change doesn’t make them any more or less hungry to find other high-performance offers.

“And recent moves by Facebook to shut down application spam only make the problem worse in some way – game developers have to spend more money on advertisers to get users now that the viral channels are shut down. That means the games have to monetize even better. Which means more scams.”

Yes and no. Yes the new changes may impact virality, which may in turn drive Facebook’s ad sales, which as I mentioned in my last post is probably not an unintended consequence. But no amount of ringtone hucksters are going to make up for that. The new platform will be all about engagement. Game developers will strive to get higher RPUs not by doubling their revenue from adding more bullshit PC Doctor DVDs, which aren’t doing that much for us anyway, but by making games that customers want to play more frequently for longer. Also new Facebook ad rules (along with Arrington’s post)have prompted many offer providers to remove hundreds of low quality ads.

On the other hand, I agree with Arrington in that the number of scammy free offers is still far too high, in that it is not zero. We personally use two offer providers. One of them (Peanut Labs) I use largely because they have the most reliable free offers, and scams are almost nonexistent. The other one allows me to block offers I don’t like, and I do this whenever we get complaints about specific ones. That’s not easy because often the customer doesn’t even remember the name of the offer that sucked them in, but I do my best to hunt them down and make sure they’re never seen on our games again.

We as game developers hate the idea of someone scamming our customers. Even discounting the ethical issues, which we do not, it’s just plain not good for us. The scammy offers are a low percentage of revenue, but a high percentage of support requests, and are probably why a lot of people quit playing our games, and therefore quit paying us money. The math just doesn’t work out. Even if we really didn’t care if our customers got ripped off (which they always blame us for, by the way, even to the point of threatening lawsuits) it still just wouldn’t make sense on our part to knowingly sponsor these.

Since my company, Blue Frog Gaming, shifted focus to developing Facebook apps nearly a year ago, we’ve seen a lot of changes to the platform. Some of them have probably been for the better, some for the worse, and one in particular has been disastrous: the rise of gifting. In the last few months it has fundamentally broken the platform.

In the early days of the Facebook platform there arose a bit of a spam problem. Developers incentivized customers to send invites to their friends, often even paying them in-app currency to do so. It quickly became obvious that apps employing such tactics could grow to millions of users almost overnight and, in the process, create tremendous volumes of invites that hampered the Facebook user’s experience.

Facebook reacted by doing a couple things. First they banned rewarding users for sending invites (or using other similar platform integration points) and they limited the amount of invites a user could send from any one app to 20 per day. The limit made it impossible to spam your entire list in just a couple clicks and the new incentive rules made users much less apt to spam over time. The idea was that if people were so constricted, and rewarded only when their friends actually signed up rather than when they sent the invite, people would be more considerate, invite only friends who might actually be interested, and the number of unwanted invites being sent out would decrease dramatically.

Those changes helped, but still they wanted to do better, so they later changed the allocations such that the “better” apps got more invites per day (up to 60) and the worst offenders were choked off entirely. Invites are the lifeblood of almost all Facebook apps, so it worked. That seemed to be an improvement until a few months ago when developers figured out how to game the system.

The problem is in how Facebook determines which apps are “better”. They do that mainly by looking at the app’s invite acceptance rate, as well as the rate at which those invites are blocked or ignored. An app’s allocations are based on how their rates compare to the median. When we first started developing about a year ago, the median hovered somewhere around 20-25%.

This method is, it turns out, easily gamed. The original solution, used by Mob Wars and the like, was to create in-game “buddies” that come from an invite and give you in-game benefits. Want to run a job in Mob Wars? You’re only allowed to if you have enough friends in your mob. Want to attack people? Your success in battle will be almost entirely dependent on your mob size. You may need 20 buddies to do a mid-level job and 500 to attack another player with any shot of success. At some point the buddy requirements get so high that the only realistic way to get them is to send buddy invites (via Facebook invites) to large numbers of people who already have the app, which you found on some large “Add Me” lists.

This of course boosted Mob Wars’s invite acceptance rate. When you install the app, you might invite your real friends for a week until you run out. Let’s say you send 100 invites to actual friends, and 10% sign up. Not bad, but you need 20 to do that next job. So you join an add-me list.

Next thing you know you’ve got 400 new friends, all of whom were on the list, and almost all of whom are sure to accept your invite request. So you invite them over the next couple weeks and they almost all accept. Despite the fact that only 10 out of the 100 new people you sent an invite accepted (not a particularly high rate) your total invites were accepted by 400 out of 500, making for an average of 80%. The acceptance rate didn’t go up because the developers made the game better, they just hacked the platform to make sure the people who already used it sent and accepted more invites.

This still wasn’t that big of a problem because most people never got that far, the needed number of friends wasn’t too high, and the active players really didn’t need to send out the full 20 invites per day for very long. It pushed the median invite acceptance rate up as RPGs grew, but not ridiculously so. Then came gifts and the rise of Farm Town.

As far as I can tell, in-game gifting as a platform hack was first figured out by MyFarm, and then later put to spectacular use by Farm Town. The idea is to have one app send many invites to people who play the game every day for as long as they play the game. Combine this with an engaging game and you’ve got an invite acceptance machine.

When you first log into Farm Town, you are taken to the gifting screen, where you can easily choose an item (such as a pig or an orange tree) and then send it to all of your friends. Each gift is a Facebook Invite that has to be accepted in Facebook (not in the Farm Town app) from your requests page. So you click the accept button, go to the app, are given the gift, then have to hit the back button and do it again for every gift you have.

Now just about everyone who plays the game is sending out the full amount of gifts per day. And what happens is that their friends who play accept nearly 100% of them. The ones who don’t click ignore once, and the ones who do click accept 100 times. As a result, the median invite rate for the entire platform has since shot to near 60%, and it isn’t because spam has been reduced, it’s because it’s been increased but the non-spam invites have been increased many times more.

Imagine if your email provider, instead of blocking spam, somehow made you receive twice as much of it but then somehow made half of their customers (of which you may or may not be one) receive 100 times as much non-spam email. Your overall user experience suffers, and in fact even the people who are getting more non-spam are suffering, but the overall % of emails that are spam just decreased by a wide margin.

That’s exactly what has happened on Facebook. Even the people who play the farm games don’t want that many invites. They want the gifts, and that’s fine, but surely nobody wants to log into Facebook, see 20 Farm Town gift invites, and have to accept them one at a time by clicking accept, loading the app, then clicking back to the requests page. It’s slow and painful. From a usability standpoint gifts should be given in-game and not even require acceptance (who would ever not want a free chicken?) but the developers get a tremendous advantage from the acceptance rate so the user has to suffer in order to help them game the platform.

Another problem this creates is that you simply cannot have a top app without gifting, no matter how nonsensical its existence in your game is, or how much it detracts from the user experience or game mechanics. Your game could be the most engaging on the platform, but without a solid gifting system your invites are going to get choked off. Take a look at Restaurant City, which is maybe the most engaging game ever launched on the platform. It’s also a great platform citizen, attempting to get new users largely by making a game so engaging people want to tell their friends about it, rather than by giving them large rewards for spamming friends.

Restaurant City’s invites per day are down to 12 and it’s a Verified App. Being Verified means it gets boosted 2 buckets in the allocations. To put that another way, if it were not Verified it would be getting 6 per day.

Scroll down through the top games on the Facebook platform and install them all, as I have, and you’ll see a trend appear very quickly. Almost all of them dump you immediately onto a gifts page every time you log in. This is no coincidence. It’s because it’s the only way to keep reasonable allocations.

The solution is simple: only count requests sent to someone for the first time when determining the median. Or better yet, switch to a better metric entirely like engagement. Facebook knows how much time my users spend on my apps (or at least they could if they so desired). Why not base my allocations on that rather than forcing me to beg my customers to send a dozen gifts with every login?

I wrote 90% of this post over a month ago, and was prompted to write it today by the fact that the platform is probably changing in about an hour and a half. I’ll admit, I’m somewhat dreading it. It’s been a long time since Facebook made a change that made me think more highly about developing on their platform, and with each knock to developers’ allocations they’re going to push more and more people off. I worry that if trends continue, at some point we’ll be left with just Playfish making new games and Zynga cloning them and then marketing them to the top. Our new game on Facebook is doing very well, and we’re already thinking about how to parlay that into a standalone web success. I know we’re not the only app developers thinking along those lines these days, and Facebook should take that seriously, if for no other reason than to give Zynga someone’s games to copy.

I’ve mentioned previously that when you’re developing on somebody else’s platform “you have to be ever-mindful of the fact that you’re playing in somebody else’s back yard”. Never has this been more apparent than when Facebook announced their new Verified Apps program going live yesterday. Apparently one of the dangers of working on someone else’s platform is outright blackmail.

Facebook really couldn’t have done a better job with this rollout, if their intention was to piss off developers. Basically here’s the way it happened. Many months ago, they announced their intention to create a Verified Apps program, wherein app developers would submit their applications for verification. We were told we’d receive various benefits, though they were murky. The only thing clear was the cost: $375 per year.

Registrations opened about 6 months ago, at which point many people paid their fee, and until today little more was said. And almost immediately app developers’ allocations (basically the amount of things Facebook lets your app do) started dropping. Apps like ours, which maintained a relatively constant invite acceptance rate, and even lowered the amount of spam reports and the like, went from being able to send out 20 invites per user per day to 16, then to 12, and sometimes even as low as 8.

This is more significant than it may sound. Many apps on Facebook spread primarily through invites, and senders seem to act in an almost binary manner, either sending out 0 on a given day, or sending out whatever the maximum allowable number is. So knocking an app from 20 invites per day down to 12 might not be exactly a 40% reduction, but it’s not very far off. Facebook was slowly but steadily choking off apps.

Games, which are the only apps on Facebook with any lasting value, were among the ones hardest hit. Meanwhile the new home page rewarded other apps that spread mainly through wall posts and feed messaging. Facebook made the already easy-to-ignore app invites even less noticeable, and hammered users with a barrage of “What Golden Girl Are You?” type garbage. Junky quiz apps that before struggled to survive rocketed to the top of the directory, while a lot of the mid-level (but growing) games saw their traffic turn into an upside down V.

With a little creativity, many of us have been able to turn it around, at least a little, but for most game developers the platform’s glory days are over, or so it seemed. But now you can get them back for the low, low price of $375! Facebook’s Verified Apps program seems to do little of any use except bump your allocations back to where they were before it was ever announced.

On one hand, I’m not as angry about it as I might sound. It’s their platform, why should they not do what they can to monetize it? $375 per year is a joke for a successful app. It’s a small fraction of what even a mid-level app makes in a day there. It’s clear that their ad platform is never going to amount to anything, so even though our apps give them a few million extra impressions per day, that’s not going to pay the bills.

On the other hand, it’s just shady how it was rolled out. It feels too much like extortion. Sell me on the benefits of Verified Apps by making it a good program. I feel like someone smashed me on the head with a baseball bat and then said “hey, I’m a doctor, you better pay me to check and see if you have a concussion.”

But, once again, it’s their house and it’s their rules, so there’s little I can do but pay my $375 and just be thankful. It could be worse, they could be Apple.