New venture outsourcing blog

In San Diego, CA, where Inventure Global is based, things are getting really bad in the housing market - and there are signs that we’ve still got a ways to go!

Things are so bad the Fed and Treasury are in full emergency mode to stop the bleeding.  The steps they’ve taken so far are clearly necessary, but they haven’t yet addressed the issue head on about how to fix the problem in the future.

The banks are looking at their books and wondering how they can possibly avoid this fiasco in the future.  Take a look at the following charts from J.P. Morgan Chase which shows the difference in loans that brokers vs. J.P. Morgan’s employees originated (the boxed area).  The 2007 YTD column shows clearly that 31% of all loans the brokers’ originated had a loan to value (LTV) of over 90%!  That’s quite a departure from the 4% or even 10% historically normal levels that were originated internally by the bank.

This is just one more piece of evidence that the brokers’ interests are not properly aligned with the bank’s.  Default rates on mortgages paint just as damning a picture for banks not being on the same team as their investors.  Given all the turmoil - is there a way to get everyone on the same side & restore order to our mortgage finance system?  In a perfect world this wouldn’t require too much new expensive regulation or new departments to watch over the industry - because that’ll cost us all more later.

The mortgage industry pays brokers to originate loans - which makes perfect sense and provides a valuable service to both the mortgage industry & borrowers when done well.  I think most of the problem is in how they’re paid.

These payments are large up-front dollar amounts paid upon the closing of the loan.  They don’t get paid any residuals on the loan at all - so once they get this check they’ve made their money and that’s it.  This is where the trouble starts.  Once the guy who’s responsibility to close the deal doesn’t care whether the borrower can afford the loan, it’s only a matter of time before there’s going to be a problem.  The truth is, that we already have a model for this.  It’s how health insurance brokers are paid. 

Pay them every month

My proposal is to change the definition of a conforming loan to include a condition that the originator is paid a percentage of the loan’s monthly payment.  Perhaps a modestly larger up front payment in order to help jumpstart a person’s career in the business - but the vast majority of a broker’s income should be paid each time the borrower’s check clears every month.  That way, the broker is incentivized to only originate high quality loans.  If the broker thinks you can’t afford the loan, it’s not in his best interest to push you into it, it’s not worth the trouble for only a couple months of tiny fractional payments.  The broker would be much better off readjusting your expectations and getting you in something you can afford.  Perfect.

No new costs 

The really good news is that the operational infrastructure already exists: this is how the investors are paid, it’s how some of the bond insurers are paid, and it’s how taxes are paid.  One more check to cut to the broker should be a pretty easy adjustment in the system - which means it won’t introduce significant additional cost.

Someone’s always vested on both sides

Additionally, it creates an adversarial environment between existing brokers & new brokers during a refinance.  If you want to refinance your mortgage and speak to a new broker about it, they may try to trick you into a new loan that’s not in your best interest.  When this happens today, that’s the end of it, it’s you versus the broker.  In a world where your previous broker’s paycheck depends on you staying in your current loan things are a bit different.  Now you have to industry professionals fighting over your business.  This is good news because they should both be better informed & equipped to slog it out on your behalf, increasing the likelihood that you’re going to get a truer picture of the situation.  Now you can choose which one really is the better option.  In fact, in order to change other kinds of insurance (e.g. life, disability, or long term care) you have to send in a Replacement Notice to your existing insurance provider - which they then send along to the broker to go fight for your business.

Require it for “conforming” loans

Why make it part of the definition of being conforming?  Because conforming loans are the ones that Freddie Mac & Fannie Mae buy.  They’re the ones that our government and our tax dollars help subsidize.  These institutions drive what’s “normal” in the mortgage industry because they’re the ultimate clearinghouse for the massive amounts of capital required to keep the mortgage securities market liquid.  By altering the definition of a conforming loan we can “recommend” that the market coordinate in a way that helps everyone out, without requiring too much more supervision or regulatory burden to the system.  Other banks can pay brokers in alternative ways - but they just won’t have access to the large pools of money subsidized by our tax dollars.  It’s up to the bank if they want to make that tradeoff on each mortgage product they underwrite.  In the long run, I would hope that this model would become the norm because it really is in everyone’s best interest, but in the short run the banks & brokers could gradually move over to the new system.

Hopefully I haven’t overlooked anything critical and when the emergencies slow down we’ll see some policy changes in this direction.

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There is an interesting post in the New York Times about Google day care.  Getting everything you ask for is a problem, once you get used to it.  As human beings we just don’t seem to be that well suited to being super comfortable.  Sadly, it tends to make us worse in all the ways that really matter.Janet Ray-Dupree also wrote a great column about the duality of those who have a mindset that’s open to growth vs. protecting one’s reputation.  The results are predictable, but worth focusing on for a few minutes, especially in the context of the Google story.  Intellectual classism is just as harsh a cultural weapon as any other kind of social division.  It requires drawing a line in the sand between those who are in teh club and those who aren’t.  Those who obtain membership have to be treated special - and there is always a growing fringe who feels it necessary to further cement their membership by ostracizing those who lack membership.  Machiavelli wrote that it is better to be feared than loved, perhaps these people are just taking a page from The Prince?Google is an amazing company, I know super smart people work there who I respect a lot, and their engineering skills are beyond reproach.  However, I’ve always thought that the most interesting inflection point in Google’s history will be the day that things stop going their way.

This post is particularly timely for me because a few friends of mine have come to me within the last couple months asking me if the culture of Google is really something they are interested in joining.  Once Google stops losing the ability to snap up the smartest and most motivated people, they’re clearly headed in the wrong direction.  It will be interesting to watch the next year or two at Google.

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I had a great discussion with some colleagues of mine which ended up on the economy.

The economy is shaping up to take quite a beating - however the way in which it affects each industry and market is quite skewed. Automotive manufacturers are taking a serious hit, but the healthcare industry is doing quite well actually. If this rough economy is doing your business a favor - then you may be in a unique position to do nothing and capitalize fully from this. However, the more interesting question is what the rest of us should do.

All business “successes” deal a direct and severe blow to someone else's industry. Two cases in point: Due to Apple's iPod, Sony doesn’t sell a lot of Walkmans anymore, and Henry Ford was public enemy #1 for the horse & carriage industries. This is the entrepreneur's “creative destruction” at its harshest, albeit most poignant, contribution to our economy. The entrepreneur is finding a latent need in people’s lives and innovating a better solution than the world knew before.

Given the wide scope of personal and business economic hardships in sight, I believe the case can be made that the glass is half full. The key insight here is to ask yourself the most basic economic question, “… and then what?” I’ll leave you with two concrete examples to spur some thinking.

Take gas as a classic case in point – so people are driving less - that’s fine… what are they doing more of instead? Talking on the phone? Work around the house?

Next up is credit. The credit markets are tightening for everyone, yet ironically interest rates are low right now. Perhaps you can determine that some segment of your customers are super creditworthy yet don’t have access to other credit sources for a few (bad) reasons. Can you offer them “financing” by removing your upfront fee & increasing the monthly fee at above market interest rates to increase your profitability and improve their cash flow? If you have cash on hand – your competition may have trouble keeping up with you!

What are three new possible opportunities that today’s economy is offering you?

I’m going to do some thinking about this myself and report back…

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The San Diego Software Industry Council (SDSIC) wants to get the word out about its annual “Managing Innovation” symposium May 15 from 8 a.m. to 3:30 p.m. at AMN Healthcare Auditorium.

Technology innovators will present on how they have used innovation to grow ideas, companies and profits. Seats range from $75 - $95 and can be reserved at www.sdsic.org or by calling (858) 793-6655.

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Speakers include:

• Mitch Oliver, Vice President of Solutions and Marketing, Qualcomm Internet Services
• Matt Porta, Partner, Technology Strategy, IBM Global Business Services
• Pete Kronowitt, Open Source Strategist, Intel Corp
• Chuck Davis, Regional Director, Open Innovation Solutions , InnoCentive
• Michael Robertson, Founder, Linspire, MP3tunes, SIPphone, and REEF
• Dmitry Shapiro, Founder/Chief Innovation Officer, Veoh Networks, Founder Akonix
• Dennis Clerke, Co Founder and CEO, Cardiff Software, Managing Director, Daggerboard
• David Merkoski, Creative Director, Frog Design
• Cary Gibaldi, Creative Director, Frog Design
• Chelsea Holden Baker, Marketing Communications Specialist, Frog Design
• Larry Kettler, CEO, Linspire
• Frode Odegard, CEO, Lean Software Institute
• Carl Eibl, Partner, Enterprise Partners

I’m going to be joining my good friends at Clearpoint Agency - it looks like it’s going to be an interesting mix of speakers this year - there seems to be more of a focus on startups.

See you there!

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I was introduced to the CEO of Analog Analytics, Ken Kalb, through a mutual friend, Neil Senturia, late last year.  Ken had a great idea for a new company - he wanted to bring the improved accountability & optimization of online analytics to offline advertising.  What was even better, is that he already knew how to do it!

The value proposition is simple:

• Build and deliver a better ad with greater returns
• Measure the ad performance in real time
• Measure the mix of media spend to improve overall advertising returns

How it works

1. The advertiser creates a call-to-action in their ad to text a short-code or call a toll-free number.  For example: “Text COFFEE to 123456 and receive a free cup!”
2. Consumers who hear or see the ad (depending on whether it’s radio, TV, newspaper, magazine, etc.) respond by calling the toll free number or sending the SMS message.
3. Analog Analytics tracks, sorts, and presents the information to the advertiser in real time through an analytics dashboard (think something like Google Analytics).

Do people respond to SMS ads?

According to a September 2007 m:metrics report, the response rates to SMS ads in Europe are between 6%-9% depending on the country.  The response rates in the US are higher, 12%, but our penetration is only 17% vs. 35%-75% in Europe.  This shows that while the US market is still developing, even with significantly higher penetration rates, the response rates are still probably going to be at least 6%.

The people

One of the great things about working with startups is the people you get to interact with.  In addition to Ken, we’ve been working very closely with Tom Buscher and Scott Willson.  Tom worked with Ken at a previous company doing telephone stuff, so he knew just how to get the backend infrastructure up & running in no time flat.  Scott is a “Coder, bike racer, husband, father” who has a great command of both user interfaces and Rails.  Both guys are really smart and it’s been great working with them; we’ve learned a lot from them both.

The future

The product looks great and it’s continuing to get better and better every day.  We’re very excited about being able to help the Analog Analytics team implement the first version of the software behind this fantastic new company.  If you do a lot of advertising, you should definitely check out what they’re up to, look at their report samples, & let them know you’re interested in increasing your return on ad spend!

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Daniel Weintraub at the Sacramento Bee wrote an opinion piece today, Silicon Valley Index shows sides of new economy, where he notes that, “Even as much of the rest of California braces for what looks like a slowdown, the state’s best known economic engine - Silicon Valley - is humming along…”  This “humming along” is being reported via the Joint Venture: Silicon Valley Network’s Index of Silicon Valley for 2008.  The economic report is quite interesting, if you’re into that sort of thing (as I am)!

The really fascinating aspect of Weintraub’s opinion piece to me though, was his acknowledgement of contrary economic indicators and how they can be resolved:

• The share of middle-income jobs in Silicon Valley is shrinking
• Share of households earning less than $35,000 has been declining since 2004
• The number of low-paying jobs is growing as a percentage of the work force 
• More households are reporting higher incomes
• Share of households earning more than $100,000 has been increasing since 2004
• The share of households earning between $35,000 and $100,000 has stayed roughly the same
• Nearly 4 in 10 households earn more than $100,000 / year!

How does Weintraub reconcile these?  He points to the increasing “free agency” of the workforce.  The Silicon Valley culture is now one of work for hire, specialists as consultants, which of course means companies are doing more outsourcing than ever before.

It’s interesting that the fraction of outsourcing has increased so dramatically in Silicon Valley and that it’s been so good to their economy.  As Silicon Valley’s bread and butter are high technology new ventures, the advantages of outsourcing for startups is apparently clear to them.  Hopefully other startups around the world will continue to follow suit!

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I love the Freakonomics blog (as indicated by the link on the right hand side of this blog!).  I wandered into a recent post about click fraud on there by Melissa Lafsky.

Click fraud is a problem under certain circumstances, but for the major search engines who use an auction system for PPC and a performance based CTR to show their ads, this really is not a big problem.

Check out the comments section on this great Freakonomics post and weigh in!

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A.T. Kearney compiled the Global Services Location Index (GSLI) for 2007. 

Perhaps surprisingly, most of the 50 countries in the index rated comparably well on financial attractiveness.  What really set India and China apart from the rest of the pack was primarily their people and skills availability scores.  The two mainstay outsourcing destinations were the second and third rated countries for people and skills availability trailing only the US, with Germany and France filling out the top 5.

This is the fourth year the top 50 countries providing IT services and support, contact centers, and back-office support were ranked on 43 measurements that determine financial attractiveness, people and skills availability, and business environment.

This year saw the addition of two additional measurements critical to determining global competitiveness: compensation costs and relative experience of BPO analysts.  The experience of IT professionals and contact center agents were already part of the index.

I decided to dig into the numbers a bit more, why is it that people and skill availability are determining the winners?  It sure seems like having favorable financial & business terms should be super valuable as well.  The answer is that these two other factors tend to cancel each other out.  If you look at the chart below, you can see that countries who have relatively strong cost advantages tend to have less favorable business environments.  In fact, the correlation between financial attractiveness and business environment was -0.81!

This tendency for the business environment & financial environment to cancel each other out, seems to be what tips the balance in favor of abundant supply of skilled people & processes.  The risk of unfavorable business environment obviously impacts the overall financial opportunity for a company looking abroad.  This study seems to support the idea that as policy leaders decrease the barriers for business to be conducted in their country (free trade restrictions, reliable contract enforcement, etc.) the financial incentives to go offshore tend to catch up and offset that gain. 

Given the tradeoff between these two dimensions, the smart money seems to be on the countries with abundant talent supply.

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In the December 2004 issue of HBR is an article by Jane C. Linder on transformational outsourcing.  Linder defines transformational outsourcing as, “partnering with another company to achieve a rapid, substantial, and sustainable improvement in enterprise-level performance.”  Moreover, Linder subdivides transformational outsourcing into four categories:

• Rapid start-up: Outsource to rapidly scale up a new business
• Pathway to growth: Outsource to fix a key process that stands in the way of growth
• Change catalyst: Outsource to signal broad change and focus on adding value
• Radical renewal: Outsource to improve core operating capability rapidly.

In the article, TiVo is described as a startup using outsourcing to ramp up to “enterprise-level performance” in no time flat.  TiVo partnered with Sony to manufacture one of their DVR designs, many affiliate partnerships to advance sales & marketing, and Metron North America for their CRM operations (which shocked their clients several years later by closing their office with only 48 hours notice!).

They began most of these relationships between 1998 and 1999 and have grown markedly into easily the best DVR offering available.  Their business model is suspect, but their time to market and product quality have been undisputed for almost a decade.  Outsourcing helped propel them from early stage startup to the top ranks of consumer electronics in just a few short years. 

Nice job TiVo.

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Dan Bingham wrote me an email today, presumably in response to Why outsourcing to India works, that began:

I thought you might be interested in the results of a study Deloitte released yesterday which basically found that outsourcing vendors and customers are rushing into outsourcing relationships focused primarily on cost, and because of this the relationships are being structured in a way that prevents them from obtaining additional value from the relationship in other areas, resulting in a great deal of frustration on both sides.

The Deloitte Consulting Outsourcing Report 2008 surveyed over 300 businesses and IT executives who used Deloitte’s outsourcing services.  These businesses were of course not startups, but it raised an interesting issue that does appear when new ventures try to outsource as well:

How do the outsourcing company and provider get on the same team?

The traditional answer here is a legal one: the contract.  You specify in excruciating detail exactly what you expect to get, what you expect to pay, and when you expect to receive it.  You should also probably pay someone a hefty consulting fee to write you just such a contract by the way!

Contracts are important, I don’t want to minimize them, they are definitely a key item of last resort when settling disputes.  In fact, a lot (most) of the value of most contracts is just the exercise of forcing both parties to go through the motions of being very specific about what they want.

However, they tend to be very much prescriptive and thus cannot accomplish much in terms of really cementing a productive relationship. 

Imagine an employee agreement which specified exactly how much work the employee would do, by when, and for how much.  How effective do you think this would be?

Some of most recent innovations in pay packages are going in the other direction: commissions, profit sharing, stock based compensation, ESOPs, 401(k).  All of these promote shared incentives.  Even union contracts generally do not specify output requirements to the same level of specificity you’ll find in most outsourcing contracts.

Is it reasonable that the way you negotiate and manage employees and groups of employees is not the same way you expect to manage outsourcing partners?  Probably not.

Ironically, we’re lucky here at Inventure Global.  Our relationship with startups has helped us avoid this for the most part.  Anyone who joins a startup, including outsourcing partners, have to be willing to be a real part of the team.  This turns out to be a much better solution.  Creating shared goals, cultivating a shared vision, and having shared values creates shared success.  There’s not as much downside protection than a contract has, but the upside has much more potential.  For a startup it’s all about upside, the opportunity is what everyone is playing for.  Other businesses have something to learn from this, they should consider weighing the opportunity of shared success over the costs of disappointing results.

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