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.

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…

Even if you think you’ve decided already, the final decision may not be up to you!  Venture capital firms are continuing to push their portfolio companies to outsource, which just another indication of how important it can be to improving valuations, time to market, and productivity of a startup.

Ann Grimes, who now works at Standford, wrote Venture Firms Seek Start-Ups That Outsource in the Wall Street Journal about six venture backed startups in 2004 who were using outsourcing: Solidcore Systems Inc., July Systems Inc., 24/7 Customer, ServGate Technologies Inc. (acquired by Cirond Corp. in 2006), ReaMetrix Inc., and Open-Silicon Inc.

These companies and their investors were all quoted in the article saying that the additional value provided by globalization and outsourcing were on the rise.  They fully anticipated (correctly) that the outsourcing trend would gain momentum as communication & other infrastructure barriers were removed.

John Shinal wrote in VC firms push for outsourcing that the VCs are not just accepting this or monitoring it from the outside, they’re aggressively pushing it on their portfolio companies!

“There isn’t a board meeting that goes by that we don’t ask, ‘Why aren’t you being more aggressive (with software development) in India and China?’ ” said Jim Breyer, managing general partner of the Palo Alto venture firm Accel Partners, which has backed more than 200 companies.”

The majority of startups that receive investments from the Menlo Park venture firm Kleiner Perkins Caufield & Byers have operations in India, Kleiner partner John Doerr recently told a group of Indian entrepreneurs in Santa Clara.

Now, nearly all the business plans that [Peter] Barris and his colleagues evaluate for the firm’s new venture fund include an offshoring component. “It’s not an unusual event anymore,” said Barris.

It should go without saying that a VC who’s got any kind of agenda, including an outsourcing agenda, that the startup firm doesn’t want to explore is a bad fit.  There are very good reasons why outsourcing for startups isn’t appropriate, but for well prepared startups the list is getting shorter every day.

As we mentioned in our previous post about outsourcing providers moving up the value chain, the trend of improved focus on opportunity-oriented outsourcing is likely to continue.  I would urge startups that are inclined to keep everything local to ask themselves why the trend seems to be so strong?  Perhaps your business is different from all the others… but probably not.  Look at this chart from R&D magazine to see that the number of outsourced functions is pretty broad now.  It’s not just customer service and tech support.

More likely, you just haven’t found the right partner yet, and as you look be sure to keep your eye out for firms that specialize in helping startups like we do.  As we all know, startups are defnitely a different breed of company!

McKinsey has put together a Project 360° for outsourcing BPO & IT work, including software development, to India.  The results of this research were a fascinating combination of insights about how companies who use outsourcing benefit, why they benefit, and how outsourcing companies will need to improve to stay competitive in the world market.

First, I’d like to start with expectations.  The study asked outsourcing clients and outsourcing company senior managers to allocate 100% over these five areas which both sides agreed were the primary drivers for outsourcing services:

• Cost

• Quality

• Risk

• Speed and flexibility

• Innovation and productivity

The fascinating thing about the responses from 50 lines of business in a dozen different companies, shown below, was how the differences manifested themselves between outsourcing newbies and veterans.

Companies outsourcing for more than three years were much less interested in the cost oriented benefits of outsourcing (cost, quality, and risk) as they were in the opportunity oriented benefits of outsourcing (speed & flexibility, innovation & productivity)!

This lines up pretty well with our own experience here at Inventure Global.  Our clients tend to engage us for one or more of the cost oriented benefits, but soon end up realizing the tremendous potential available on the opportunity side of the equation.  After the first year, the excitement of a one time cost savings wears off.  The idea of increasing your growth rate year after year never gets old!

Another truly welcome surprise is how far behind the curve most of our competition’s senior managers are.  From the chart above you can see that the vast majority of outsourcing firms focus exclusively on cost oriented benefits to their customers.  This is a great place to start, but in the future cost alone won’t keep them in business.  The study clearly found that the winners in tomorrow’s outsourcing landscape will need to help their customers innovate, get to market faster, and offer their help in a flexible manner - that’s almost Inventure Global’s mission statement!

Finally, the study surveyed a substantial number of companies that do their work in house and offshore (captive) and those that outsource and offshore.  On average a 30% improvement in productivity appears to exist between outsourced service providers and similar in-house departments, even though both use an Indian based workforce.  This dramatic difference is probably due to the increased competition among outsourcing companies who need to continually improve their people & processes in order to stay competitive.  In the long run I’m sure in-house teams will catch up, but the market is less forgiving in the short run.

The survey concluded with some closing remarks about the outsourcing IT industry:

• A company culture of institutionalizing practices separates the winners from losers.  The winning firms have been able to successfully absorb 15%-18% increases in wage inflation through added productivity.

• Despite good customer satisfaction & project outcomes overall, there is still significant variance.  You can’t bank on the results from just any firm.

• Customers are increasingly looking for upstream value added services like requirements gathering & design, but existing companies do not have robust enough offerings to fulfill the demand.

• The industry needs to continue focusing on improving performance and consistency.

Inventure Global operates below the radar of McKinsey right now, but so do our customers!  Startups are definitely a bit different than big companies in quite a few ways, but many of these results mirror our experiences as well.  I think the opportunity oriented benefits are the real takeaway for us, our customers are constantly asking for help innovating and getting to market faster.  You can’t run a business on cost cutting alone, you have to differentiate to survive, so in the final analysis this doesn’t come as too much of a surprise to us - hopefully it’s another two or three years before our competitors notice!

Coming from the data mining and machine learning field, a few friends of mine have been kicking around the idea of whether data or analysis is a more valuable asset.  Obviously the two have a symbiotic relationship to be valuable together.  If you can have both you’ll take it, but what if you had to choose?  Is it generally true that in most areas of business you have to specialize - which means prioritizing certain activities, skills, or knowledge over others.  Should you choose to get better access to the data or should you choose to get better at analyzing whatever data you have available to you?  If you’re in an analytics heavy field - is there an inevitability that one or the other will win in the long run?  If not, under what conditions might one be the better option? 

I originally started thinking of this in terms of “Which would cost you more if you had to buy it?”  Would it be cheaper to have the ability to analyze data well, and have to “purchase” the data from someone else - or would it be cheaper to have the ability to obtain, store, and access the data well, and have to purchase the analysis from someone else?  Microeconomics says that value is all about scarcity, so this line of thinking led me to conclude that decent analysts will always be cheaper (on a for-hire basis) than access to all but the most plentiful data.  Therefore, if the data is abundant then it might make sense to specialize in its analysis, but under almost any other circumstances you should choose to be the one who has better access to the data.  Point for data. Algorithm design, analysis, whatever you want to call it is basically a particular example of human ingenuity.  Therefore at any moment in time, someone has come up with the “best” way to analyze some data for a particular purpose.  However, innovative people all over the world are hard at work to put that person’s idea out to pasture even before the idea has been tested.  Therefore, cutting edge analysis has two properties relevant to this discussion.  First, it can increase the value of the data by a quantum leap when a new theory emerges.  This makes it a very valuable contribution for a period of time.  However, inevitably, how long this lasts is hard to predict.  It could be the decisive contribution for a year, five years, a decade, or a few decades.  The only thing we know for sure is that it will not be king forever.  Still, whoever owns the best analysis in the world for a given situation is arguably bringing a very unique value contribution to the table and if protected properly can be quite scarce.  Point analysis.

Brad Burnham at Union Square Ventures considered the problem in a much better way.  He posits that data has an increasing marginal utility.  This is a very important characteristic which says that every additional piece of data you get is more valuable than the previous one you got.  Why?  Because with proper analysis, you can tie that single new piece of information together with potentially all of your previous data.  This network effect of data is very insightful.  It says that knowing your location and knowing what you search for on the web are both valuable in their own right, but knowing them together is even better (think relevant & localized ads).  Nice work Brad.  Another point for the data.

What about analysis, does it have any “network effects” or compounding effects to counter the effects we just saw that collecting more data has?  I think it might.  The data people have a cost structure problem.  The cost of getting & storing a lot of data can be quite high.  The trend is that data from transaction or event monitoring is growing exponentially.  The cost to store the data is also declining exponentially, which is good news for the data guys, it means they have a chance at least.  However, the costs to access & transmit the data is not decreasing nearly as fast.  Also, the cost to power (literally, in terms of electricity) the storage systems is becoming a problem, and not decreasing nearly fast enough to be meaningful.  Point analysis. 

The more I think about, my gut instinct says that data is the only way to keep a lasting competitive advantage.  However, if you want to make a quick strike against your competition, it seems that analysis may be the way to go.  Perhaps the right strategy is to try to shift from one to the other?  This could definitely use some more consideration.  I’m going to be on the look out for some good case studies out there.  Maybe Google, eBay, and even the phone companies provide good examples on what to care about here.

A very interesting insight from Brian McAndrews, a Microsoft SVP in charge of advertising and publishing, used to run aQuantive until Microsoft acquired them.  He says that search is getting paid too much to deliver people to websites as the final stage of the advertising process.

This is part of an effort by his team to give advertisers a fuller picture of how all of their advertising is contributing to web visits & sales.  This concept is being named “conversion attribution” by McAndrews & his team.  Frank Watson at searchenginewatch.com made a good point that this sounds great until you realize that every activity on the web has to be recorded in cookies to get this to work.

Here is a 15 page presentation where McAndrews makes his case for conversion attribution in slightly more detail.

Personally, I have mixed feelings about it.  I bet that if you do the math on how often and when people see various ads you will find out that search ads are less important than most people think they are today.  However, the bad news for advertisers, is that this probably just means they’re not paying enough for the other forms of advertising.  I seriously doubt search is anywhere close to maxed out on the revenue they’re receiving from each search.

However, search is normally a part of the last leg of the buying process - which is always the hardest part.  Closing the sale generally earns an outsized share in the offline world.  Why should we expect things to be so different online?  I think McAndrews is on to something, but maybe not as much as he’d like.

Earlier this evening I gave a talk to a group of bright, young, aspiring, entreprenuers - all part of the UCSD business plan competition.  I was asked to cover the fundamentals of entrepreneurship in about an hour!  Happy to support their impressive efforts, I agreed to take on the most difficult talk I’ve ever given (a two years of a full time MBA isn’t be enough to cover this topic).  Here are some of the highlights:

-work with capable partners

-build an excellent, interdisciplinary team

-get started now

-thoroughly analyze your competition

-get started

-be able to talk about your ideas but don’t give away the secret sauce

-be passionate about your technology and the way you’re making meaning in the world

-get going

-cool technology and good business aren’t always related

-know your customers

-make some progress on what you’re proposing

-focus groups, surveys, or online analysis can work wonders

-make use of advisors, mentors, and professionals

Shawn Purtell at ROI Revolution has a great thread on combining google analytics and google website optimization.  This is a really important step as we don’t consider hte website optimizer to be powerful enough for most people on it’s own.  Additionally, he updated his tip in June by showing how you can read the data within the new google analytics interface. It’s great that Shawn is keeping this thread current - but I’ve got one minor point of clarification. I don’t think the integration is exactly the same.  Using the new analytics I would highly recommend people not exclude their “combination” URL parameter using the exclude list within the google analytics campaign setup.  Otherwise the different combinations won’t appear in the reports.One good option now is to leave it as a visible parameter, which is totally reasonable.  The down side is that you’ll be splitting all of your traffic to your pages over these various combinations so historical comparisons will be harder.

The other option is to store the parameter as a “user defined variable” within the google analytics results.  Unfortunately, you only get one.  Shawn has cautioned, appropriately, that he likes to us his user defined variable for other things - so be sure you don’t need it if you use this option.

By turning a problem’s definition on it’s head - the reCAPTCHA team at CMU has done a remarkable job of innovating a solution to two problems at once.

You know the jumbled up words you have to type in to a website if you forget your password or post a comment on some blogs?  Those are called CAPTCHAs.  Their designed to try to determine that you’re in fact human.  These are very common - there are more than 60 million CAPTCHAs being answered every day!  Here are some great examples from Greg Mori’s research on breaking CAPTCHAs!

(A really hard one)

 

  (A much easier one - Mori’s program, EZ-Gimpy, can beat 90% of ones like this)

 

The folks at CMU asked the question in reverse.  What problems are so hard for computers - that even at state of the art we’d rather have a person solve them?  The reCAPTCHA team thought that Optical Character Recognition (OCR) problems were the answer.

OCR is far from perfect - and the Internet Archive is scanning tons of books - some of which have degraded looking text.  Here’s a great example from their website:

So how can these be fixed?

The idea is two have a program generate a known random word and convolute it to make it hard for a computer to read.  Simultaneously, it selects one of these pre-OCR’d words at random (from the top line) that it’s having difficulty OCR’ing.  Then, the human is asked to correctly type in both words.  If the response is correct for the known word, then it’s assumed that the response was done by a person, and records the person’s answer to the second (unknown) word!

Now, people aren’t perfect either.  So in reality there are a lot of complexities here.  To name a few: more than one person is shown a particular group of characters to verify that they agree on what the correct answer is, the order of the known vs. unknown words are randomly chosen, the degradedness of the word images chosen is optimized to be most beneficial for both security & effectively leveraging the human work for OCR.

The project is called reCAPTCHA and you can learn more about reCAPTCHA by going to the project page itself.  Great job guys!!

We are very proud to be quoted on page B3 of today’s Wall Street Journal on the subject of online brand management and marketing. The original discussion centered around coverage in the:
The WSJ Small Business Link

and discussion on

The WSJ Forum

which lead to coverage in the print edition (registration required to view):

WSJ Marketplace Section, The Conversation Continues

Thank you to the writers and editors of the Journal for sparking a timely and informative conversation…