In Frothy times, marketing costs rise to the top

Methinks Fred Wilson is forgetting the Dotcom era:

A very experienced and successful entrepreneur came into our office a week ago to pitch his latest company. At the end of his pitch he showed us some numbers. Normally for a raw startup we see almost all product and engineering expenses (headcount). But his plan had a monthly budget for customer acquisition. After he left, we talked about his plan and my partners focused on the customer acquisition number. It bugged us. It felt wrong.

So a few days later, I called him. We talked about what we liked about his plan and pitch and what we didn't like. I brought up the customer acquisition line item at one point in that call. He said "every company needs a marketing budget." It seemed like a strong reply but in truth not one of our top performing companies had a marketing budget in their initial business plan.

Zynga has spent millions on customer acquisition and continues to do so. But in the beginning, when Zynga was three or four people and they launched Texas Hold'em on the brand new Facebook Platform, they didn't spend any marketing dollars. That was the beauty of that time and that plan. The Facebook Platform was free distribution. Zynga rode that free distribution to millions of users, profits, and additional games. Only then did they start marketing.

The rest of Fred's post is some sensible advice on where low cost marketing can be found today, but - if you believe our hypothesis that we are in Early Bubble stage - the need to increase marketing costs is entirely understandable - to recap, our (slightly tongue in cheek but still directionally accurate) "10 Steps to a Bubble" notes the stages one goes through to Bubblezenith:

1. There is a New New Thing that trancends the Old Economics, and you cannot value It the Old Way. This Time It will Be Different. Dumb Money companies start paying over the odds for New Thing acquisitions.

2. Smart people who have been there before start calling it a Bubble (or at least a "Frothy Market"), New New Thing apostles make ever more glowing claims of the dizzy heights available, while "Startup Networking Events" start to proliferate.

3. Companies with founders deemed to have "rubbed off the right stuff" (ie sons of, ex employees of, etc etc) get funded straight off at eye watering valuations for next to no product proof or traction.

4. There is a flurry of new incubators and funds started by (newly minted) VCs

5. Companies start getting funded "off the slide deck" with no actual product

6. MBAs start leaving banks to start up companies

7. The "Big IPO" happens (Netscape et al)

8. The big Investment Banks start to make a market in the New New Thing, punting in your pension money, and have "entrepreneurial" options and divisions to retain les autres MBAs

9. Your Taxi Driver gives you advice on what stock to buy - you punt in your own pension money

10. A New New Thing darling buys an Olde Industry thing at Stupid $$$. This is the Top Of The Bubble.

One of the things that defines a bubble is that too much money chases too few assets (in this case decent startups) - but the market abhors a vacuum, so the next thing is a flurry of production of new (me-too startup) assets to fund - so more startup teams leaving MBA school, more First Tuesdays, more Incubators, the start of funding at silly values "off the slide deck" - and it means a vast increase in startups also scrabbling around in the darwinian mire that one has to kick off the slippery ladder to get one's own hands on the rungs - and that means more and more shouting.

As the bubble grew the last time, the old saw was that a dotcom was just a simple device to transfer (your) money from Wall Street to Madison Avenue via Silicon Valley. If our hypothesis is correct, we are heading that way again - so sorry Fred, it ain't gonna get better for a while I'm afraid