Optimizing for Fundamental vs Strategic Value

Every week I meet with different entrepreneurs asking for my advice on topics ranging from funding strategy, exit opportunities, user acquisition, monetization, to technology investment. However, unlike others who often have a set of best practices they like to dispense around these topics, I find myself spending a considerable amount of time understanding the entrepreneur's personal goals before laying out my recommendations.

Entrepreneurs come in all shapes and sizes and there are a variety of successful outcomes that can be achieved. It's therefore important to be wary of anyone that gives you one-size-fits-all advice before understanding your needs.

One dimension along which I wanted to elaborate is a founder's choice to optimize for building fundamental vs strategic value. Let's start with some definitions. An entrepreneur that focuses on building fundamental value is optimizing for creating a standalone business that generates meaningful cash flow and profit as an independent entity. On the other hand, an entrepreneur optimizing for strategic value is one that is building their organization in such a way to maximize potential value to a larger organization that will ultimately benefit from an acquisition of the entrepreneur's startup.

When superficially looking at these definitions, one could argue that every startup is in the business of generating profits and therefore all startups are focused on building fundamental value. In addition, one could also argue that these are not mutually exclusive and ideally when an organization is building fundamental value they are also increasing their strategic value for potential acquirers. While both of these statements are true, the reality ends up being much more nuanced.

With the nature of startups having limited resources, entrepreneurs find themselves either consciously or unconsciously biased towards optimizing for fundamental or strategic value. With every decision an entrepreneur makes comes a set of trade-offs that could result in the maximization of either of these types of value. And a lot of my advice on the topics above depend on which direction you go. For example, your funding strategy may vary significantly depending on the outcome you are optimizing for. The timing in which you choose to focus on monetization may also differ depending on this strategy.

Let's take a look at some concrete examples.

Last.FM, a social music service founded in 2002, was ultimately acquired by CBS Interactive for $280M in May 2007. I remember chatting with Michael Marquez, who was in charge of the acquisition at CBS, about why they ultimately decided to purchase Last.FM. As a media conglomerate, CBS was very interested in aggregating meaningful target demographics that they could monetize by leveraging their existing sales force and brand relationships. At the time Last.FM had one of the largest online music communities. In addition, Last.FM had experimented with a variety of ad units and had shown some initial traction on ability to monetize it's inventory. However, Last.FM had not built out a large sales team nor was it already making meaingful revenue. It had simply shown that it worked on a small scale, which ultimately proved to CBS that if they married their own large sales team with the Last.FM inventory, it could be a match made in heaven. Last.FM's decision to focus on growth at the time clearly helped to boost it's strategic value. In addition, it's revenue experiments without huge investments in building out a large sales organization also improved strategic value.

imeem, similarly, optimized for strategic value. While imeem was interested in reaching profitability to ensure its on sustainability, it nonetheless regularly made decisions to trade-off short-term profitability for maintaining strategic value. For example, imeem could have chosen to stop servicing international markets that were shown to have little monetization potential, yet continued to do so in order to maintain its large user audience that could be attractive to an acquirer. Similarly, when imeem's VIP subscription service started to show traction, imeem could have decided to push more free features into the premium service in order to boost revenue, but leadership chose not to out of unwillingness to alienate it's large free user base. Unfortunately in the end for imeem this bet did not pay off since the market for such media acquisitions softened, imeem was unable to prove profitable per unit economics to potential acquirers, and it simply ran out of cash to continue fighting the good fight.

LinkedIn, on the other hand, continually shows that it is focused on building fundamental value. LinkedIn has been profitable for years and many say it's an ideal IPO target. While they are in no rush to actually pursue the IPO, the decisions they make on a day-to-day basis are optimizing for fundamental value. One example of this is their API platform. While they have finally released an API platform, it is by no means as open or powerful as similar platforms from other social nets like Facebook and Twitter. And in many ways it has to do with the fact that LinkedIn has existing revenue lines from paid subscriptions for pro users and recruiters, as well as licensing and advertising revenue, which they are unwilling to sacrifice simply to provide a more open API to their users. Some may argue that this is shortsighted of LinkedIn in that a more open API may result in an ultimately more profitable business, yet you can't argue with the fact that LinkedIn is consciously making the trade-off to continue to maximize it's fundamental value over all else.

My point with these examples is to show how decisions are made in startups every day that trade-off fundamental vs strategic value. There is no "right" answer on whether to optimize for one or the other. It depends on a combination of the founder's personality, risk tolerance, desired company culture as well how best to reap the value in the specific opportunity one is pursuing.

In the end though, the answer I hear most frequently from entrepreneurs is that they are pursuing fundamental value but are opportunistic about considering strategic opportunities. On one hand this is a very reasonable answer as entrepreneurs don't want to take options off the table. But at the same time, it's really a non-answer and I urge entrepreneurs to consciously realize what they are currently optimizing for in the decisions they make every day.
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