Web Businesses are Easier

After a career spent in investment banking (long time ago) and then media and broadcasting I moved into the online world in 1998 when I became CFO of CBS MarketWatch. Since then I've worked with a number of venture backed companies both in the virtual and physical worlds.

Working with companies that operate in the physical world, I was CFO and then CEO for a WISP that offered service over 10,000 square miles in N. California and then CFO for an advertising network with hundreds of locations in high traffic sites around the country.

Both companies owned the equipment and had to keep it operating. Which required people traveling to the sites, equipment manufacturing and inventorying, supply chain management, NOC's with level I and level II responses, and so on.

Contrast this with the typical operations of a web (or software) company. The heaviest infrastructure lifting is likely to be at server farm all of which is easily outsourced. Obviously there is a premium on creative/compelling/unique/cost effective product development but that is also a requirement of companies operating in the real world. Another area where web companies compete hard is in customer pick up (how many social networking sites are out there?) but then again companies in the physical world compete here as well.

The obvious implication is that, for companies of equal size, businesses operating in the physical world will tend to have higher costs and commensurately lower margins than companies operating online. No surprise here...look at the EBITDA margins for Google, or for even for traditional broadcasting companies. Assuming one gets to breakeven it will be easier for web based businesses to build profitability.

The thing that struck me (sometimes directly in the face) working inside these businesses was not just the financial implications but what this means for the diversity of skills and the level of teamwork required to make these complex businesses succeed. Think of it this way: If there are 8 steps required to deliver a product to the customer in a complex real-world based business and you are only 80% efficient at each of the steps, than you have essentially lost any hope of reaching profitability. And all 8 steps need to be synchronized to maintain efficiency.

It can be done but it takes time, capital, teamwork, and experienced management. Amazon.com is an interesting example. Despite having a great marketplace, brilliant founder/CEO, and instant public awareness as an original .com success it took billions of dollars and years to become profitable. And Amazon is a hybrid, operating a somewhere between a web and physical business.

There are plenty of wonderful non-web businesses out there. And when successful the barriers to profitable operation are also effective barriers to entry for new competitors. But if considering entering one of these companies be sure that you have 3x the capital, time, and patience you expect to need.

Lastly, I wonder the extent to which most venture investors are suited to back these more complex businesses. Other than the relative few that focus on hardware or perhaps chips, the majority of VC's have deep roots in software or more recently web businesses. Their requirements for capital efficiency and rapid development are inconsistent with companies with complex value chains.