Bill Gurley, a general partner with Benchmark Capital, takes a look at this strategy when it comes to setting what he calls the rake, or commission, between a platform owner and those using the platform. Examples of the rake include Apple’s 30 percent fee on apps in its App store as well as the service fees associated with oDesk or OpenTable.

Gurley’s article, which is well worth a read, explores the relationship between the rake and the spread of the platform through a series of anecdotes. I just wish he had some documented research; not because I think his conclusions are wrong, but because I think we’d learn even more about how the cost of doing business on a platform affects volume in more subtle ways.

For example, Gurley makes much of the benefits of having a low rake, which encourages developers/end users/merchants to use the platform and also prevents a newcomer from coming in and undercutting you on price. What he doesn’t dig into is how the benefits of scale in the digital world mean that undercutting people on price is a race to the bottom. This is one reason people are concerned that no one but Google can compete with Amazon Web Services when it comes to cloud computing, despite Microsoft saying it will match AWS pricing on its own Azure cloud.

Here’s Gurley’s take on competition and the set rake:

If your objective is to build a winner-take-all marketplace over a very long term, you want to build a platform that has the least amount of friction (both product and pricing). High rakes are a form of friction precisely because your rake becomes part of the landed price for the consumer. If you charge an excessive rake, the pricing of items in your marketplace are now unnaturally high (relative to anything outside your marketplace). In order for your platform to be the “definitive” place to transact, you want industry leading pricing – which is impossible if your rake is the de facto cause of excessive pricing. High rakes also create a natural impetus for suppliers to look elsewhere, which endangers sustainability.

And here he is discussing a favorite business model for digital platforms — a low rake with a mechanism for people who want to spend more to do so in exchange for better placement or the opportunity to get favorable placement on the platform:

You start with a low rake to get broad-based supplier adoption, and you add in a market-driven pricing dynamic that allows those suppliers who want more volume or exposure to pay more on an opt-in basis. This way no one leaves the network due to excessive fees, yet you end up with a higher average rake over time due to the competitive dynamic. And when prices go up due to bidding and competition, the suppliers blame their competition not the platform (part of the genius of the Google AdWords business model). This also allows you to extract more dollars from those suppliers who desire to spend more to promote themselves (without raising the tax on those that don’t).

The article is worth reading, and I hope that some MBA professor takes it into his head to start some rigorous research on the best commission structures across digital verticals, or perhaps the biggest factors that should influence your rake rates. Because while generally low is good, if one could manage to be an area where high or medium works — at least for a while — then why not start there and see what happens?

Or better yet, invest in tools that allow for dynamic pricing based on the user’s need or demographics. That’s something more easily done online and is utterly neglected in Gurley’s article. In a digital world, the cost of goods is lower, so the risk of playing with pricing is lower as well. I think we’re going to see a lot more of it.

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These deals don’t really tell the story of Gurley. I first met him when he was a former Wall Street analyst and our relationship began with me questioning his analysis. He switched teams and joined Benchmark at the height of the first Internet bubble. Gurley, who in the past used to write the Above the Crowd column for C/Net, took a step out of the limelight. Of course, that is par for course, investors at white-shoe firms tend to be less public than analysts, so our interactions decreased overtime.

When I moved out to San Francisco almost a decade ago, we touched base again, and since then have made it a point to see each other at least once every quarter. He has a very unique point of view about Silicon Valley, the technology industry and the kind of companies he likes to invest in. Polite as he is, he doesn’t sugarcoat anything and has given me advice over the years that was a bitter pill to swallow at the time, but in hindsight, turned out to be exactly what I needed. The only thing we don’t agree on: his love for sports that don’t make sense to a short, somewhat rotund guy like me, basketball and college football — the American kind.

Last year Chris Albrecht and I did a lot of documentary style interviews with folks such as angel investor Chris Dixon, Square COO and angel investor, Keith Rabois and Zimbra co-founder Satish Dharmraj, but this year I took a step back, mostly because I wanted to regroup and rethink whom I wanted to interview. I wanted to bring fresh insights from people whom I respect and believe have something interesting to say. I couldn’t find anyone better than Bill Gurley to kick off this occasional series.

In this interview, Gurley talks about a whole bunch of things including the craft of being a VC, the changing VC landscape, and most importantly, his thesis around reinvention of everything local. The interview was 45 minutes, so we have made it simpler by creating six chunks for easy consumption. We will post the entire interview later. Enjoy the videos.

What it takes to be a VC.

What is the role of a VC? Questions every entrepreneur should be asking.

How network effects reshape local commerce.

What it takes to survive downturns.

Beyond the obvious: What are the opportunities in venture capital?

On Above The Crowd [Slight audio issue here.]

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Box CEO Aaron Levie

A few months ago, Bill Gurley wrote a post about Benchmark’s investment in Dropbox, and why Dropbox’s cloud-based file synchronization is a major disruptor. Many disagreed, quoting Steve Jobs’ assertion that file sync is a feature, not a product. As a feature, the assumption was that it would be folded into the architecture of the bigger players, once they came to market with a comparable offering.

Enter the giants.

The bigger players have arrived. Microsoft recently gave SkyDrive a major overhaul, and Google brought out its long-awaited Drive. Apple had already launched the iCloud product. It’s no accident that three of the world’s most powerful technology companies have entered this market in tandem. It speaks to the importance of cloud storage, and means that the theoretical discussion about what might happen will quickly give way to the reality of what does happen.

ScaleVP is an early investor in Box, the leader in cloud-based enterprise file sharing. No surprise then that I agree with Bill Gurley, but I would frame the discussion more broadly. File synchronization and file sharing are both “just” features, but they are features of an emerging architecture for PCs, tablets, and smartphones, one where files are stored in the cloud, accessible across all devices and cached locally as needed.

This is a shift from the device computing architecture that has persisted since the Apple I, through the entire PC era and into the early years of smartphones. That this shift has now been endorsed and embraced by the three companies who collectively set the direction of the technology industry is huge validation. It means that this change is going to happen.

For startups like Box and Dropbox, this is a big deal. The typical risk early on in the life of a startup is, “will this change even happen?” That risk is behind us. Now, the issue is whether they ultimately become features, products or companies?

Feature, product and company

Drew Houston CEO of Dropbox

I believe that the answer for the startups in this space is all three: they will become a feature, product and company. To get any traction in software today you have to start with a feature — an atomic unit of delight. You have to solve one problem superbly. From that point of view, being labeled a feature is actually a compliment, as it means you have made something drop dead simple to adopt.

Dropbox made it really easy for an individual user to sync files across multiple devices. Box made it incredibly simple for businesses to share files and collaborate in a structured manner. You can call these mere features, but they were features that people really wanted, and they were valuable enough to motivate tens of millions of users to change behavior and move their files to the cloud.

A startup with that traction has earned the right to parlay. Now, it can build a product around that feature. Dropbox and Box are doing that right now. The products they are building are next-generation file systems for the cloud, Dropbox coming from consumer roots, and Box from an enterprise perspective with a focus on collaboration. A file system is not a feature, it is a big deal product, and successful file systems have built successful multi-billion dollar companies in the past, such as Microsoft, Novell and Network Appliance.

The file system descriptor is not perfect, because traditional file systems have tended to be invisible to users, bundled in a device OS or a network OS. These new products thrive on visibility because ease-of-use and real application level functionality have been the drivers of mass adoption, but the technology that powers consumer sync or enterprise collaboration is ultimately based on managing the storage of, and access to, files in the cloud. So calling it a next generation cloud-based file system is a good enough description for now.

Competing with giants

Google, Microsoft and Apple won’t just roll over and die. They will compete hard, using tight technical integration with their existing products and financial bundling to drive adoption. If this is just another feature war, this strategy will work.

If it is an architecture shift, and the opportunity is indeed for an independent cloud-based file system, the old guard’s strategy, with the inevitable “installed base” driven trade-offs, will fail. The trade-offs will cripple the functionality of the offerings in a market where the best product will be the one that is file type agnostic and takes advantage of what a cloud based architecture can offer.

Two giant markets: Consumer and enterprise

Put your stuff in the cloud instead.

I have been talking about this as one market, but it is really two. And it will have two winners. A consumer file system based around sync is very different from an enterprise file system based around sharing. Some of the comments around “sync is a feature” are driven by people’s familiarity with the needs of end users, and lack of familiarity about what enterprise IT needs.

Consumers require platform integration to Facebook, Twitter and other consumer apps and even products (TV, Xbox) while enterprises require platform level integrations to directory systems, security systems and legacy applications. Both are hard problems and both require a platform play with huge scale. But they are very different.

In the next ten years, consumers and businesses will move much of their file storage to the cloud and in the process create multi-billion-dollar software markets for cloud-based file systems. Everyone has files. As a result, the cloud-based file system opportunity is a big prize, possibly the biggest prize in cloud computing.

For the business market alone, at an estimated $50 per user per year, with 200 million knowledge workers worldwide. This is a $10 billion annual market. My gut is that it will be won by those companies that solve the problem holistically, rather than simply bundle it in as a feature. The features are already becoming products, and these products will give rise to some pretty important companies in one of the most meaningful markets of this technology era.

Rory O’Driscoll (@rodriscoll) is a managing director with Scale Venture Partners, where he invests in mobile, Internet, and enterprise software companies. He is a board member and investor in Box. You can find more from Rory via his blog.

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By all accounts, Dropbox provides a slick way to upload and store digital paraphernalia in the cloud. From there, users can access their stuff from any device and sync files across devices. The service has been hugely popular: As of four months ago, Dropbox claimed more than 45 million users. But the success of the five-year-old company has bred imitators and competitors, including the biggest companies in tech.

The new private camera upload feature will let users take their photos as always but then easily move them from smartphone, tablet, camera or SD card to their cloud data trove using Wi-Fi or their cellular data plans. Dropbox uploads the photos and videos in their original size and full resolution to the user’s camera upload location. The feature is available now for Android phones with Windows, Mac and iOS support to come, Dropbox said.

Hardware makers hedge with Dropbox

This is one example of how Dropbox is trying to stay ahead of the curve and make itself an indispensable tool for connected consumers. In that, it has some formidable partners. Just this weekend at the Mobile World Congress, HTC said buyers of its new HTC One phones will get 25 gigabytes of Dropbox storage free for two years. Handset makers like HTC see Dropbox alliances as a way to combat Apple’s iCloud initiative.

Dropbox’s popularity has certainly been noted. Companies from Microsoft to Apple and (probably) Google are trying to mimic its capabilities. “Everyone wants to be Dropbox,” Andres Rodriguez, the CEO of storage specialist Nasuni, told me recently. Steve Jobs, the late CEO of Apple, reportedly wanted to buy the company. When that didn’t work out, Jobs called Dropbox “a feature, not a company”  and launched iCloud.

That “feature versus company” meme has dogged Dropbox ever since and cropped up again this weekend when PandoDaily’s Farhad Manjoo weighed in on Jobs’ side of the debate:

Dropbox is a great little file-syncing app, and founder Drew Houston and crew are already making some nice money out of it. But is it a $40 billion company? I doubt it. And when I hear folks like Benchmark’s Bill Gurley suggesting that it might be, and calling Dropbox “a major disruption,” I wonder if they’ve simply been blinded by the thrill of using an obviously well-crafted utility.

Dropbox is slick, and it supports nearly all the relevant clients. But in Manjoo’s experience, that support is uneven. Dropbox is often flummoxed by OS- and application-level problems, he wrote.

But any neutral party without access to Apple’s native hardware hooks will be somewhat stymied. Plus, that only takes into account some of Dropbox’s value, argues Posterous co-founder and venture capitalist Garry Tan. On his blog, Tan writes that the tech giants (Google, Apple, Microsoft) that make their own OSes and applications have no incentive to make them sync well with others.

What are the odds of Apple getting their sync client right for PC’s? Just about zero, considering what they’ve done in the past with MobileMe sync.

Same goes for Microsoft writing sync software for the Apple platform. Arguably Google is in the best shape to provide a seamless multiplatform experience . . . well, except for iOS! The odds of a viable multi-platform option emerging from one of these big three seem slim to me.

Those who forget history . . .

The cautionary tale for Dropbox is that the best technology doesn’t always win. (I would insert the Betamax vs. VHS argument here, but no one remembers it anymore.) Should Microsoft, Apple or Google offer at least reasonably good cross-platform file storage and sync capabilities, Dropbox will be in trouble. Working in Dropbox’s favor is that CEO Drew Houston appears acutely aware of history.

According to this Forbes magazine account, when Apple announced iCloud, Houston shot off a memo to employees, reaffirming the company’s status as one of the fastest-growing companies in the world. Then he listed several other once-fast-growing companies: MySpace, Netscape, Palm and Yahoo.

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Damn straight — get them (the board) out of there. The Journal reports that Yahoo has hired executive recruitment firm Heidrick & Struggles to help find new board members. Here is my unsolicited advice — from a post I wrote in September 2011.

Here are the kind of people I am thinking Yang should be calling — Paul Maritz of VMWare, Sheryl Sandberg of Facebook, Verizon CEO Chairman Ivan Seidenberg and Paul Jacobs of Qualcomm. They can bring insights into cloud, social and mobile landscapes. To get a better grip on Silicon Valley and early stage innovation, Bill Gurley of Benchmark Capital and Reid Hoffman of Greylock Capital are two names that come to mind.

Mickey Drexler of J.Crew or American Express CEO Ken Chenauth and Ford CEO Alan Mullaly. They would bring vital insight into retail, money and transportation in the era of “connectedness.” And to top it off, Yang should get former News Corp. president Peter Chernin, who started his own entertainment company, to sign on as the chairman of the board.

Okay, perhaps I am being too optimistic about Sandberg, who likely will have her hands full with Facebook this year.. But this a good short list to start with, especially if new CEO Scott Thompson wants to make innovation his focus.

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Reed Hastings’s exceptional leadership, team, and execution created a sprawling, beautiful castle..on quicksand. Setting up a perfect short which underscores my belief that truly enduring consumer internet businesses dont buy the bulk of their users. [Fenton on Twitter]

In a blog post, Fenton’s colleague at Benchmark Capital, Bill Gurley wrote:

Netflix is an amazing company, and Reed Hastings is one of the best CEO’s Silicon Valley has ever seen. That said, at age fourteen, the digital world is forcing Netflix to execute a pivot. And the world they are entering is radically different from the world they are leaving. There is no longer a first-sale doctrine to keep things neat and tidy.

Benchmark has been an investor in online video companies such as Metacafe, Clicker (acquired by CBS Interactive) and Vudu (acquired by WalMart.)

Pandora’s management team rang the opening bell today at the New York Stock Exchange. Pandora stock opened at $20 a share and started trading at $20.30 a share, giving the company a market capitalization of over $3 billion – not bad for a company that has never made a dime in profits and has been subject of negative press attention as such. The stock is trading at around $23 a share at the time of writing.

Pandora is part of a new wave of Silicon Valley companies that are tapping the public markets, leading to talk of a technology bubble. LinkedIn and Fusion-io are two companies that have also tapped the public markets recently.

Benchmark Capital partner Bill Gurley believes that “The buy side of the market has been desperate for more product” and as a result there is demand for initial public offerings. These IPOs are going to inspire other companies to go public as well.

With the exception of those two, the tech IPO market for 2011 isn’t doing too well according to Deutsche Bank research. In a note to their clients last week, investment bank’s Ted Tobiason wrote:

Two more tech IPOs priced this week bringing the total number of issues for the year to 22 with proceeds of $5.8bn. This compares to 10 tech IPOs at this time last year raising $1.0bn. However the market is showing some signs of stress. Of the 50 tech IPOs that priced in the last twelve months, 40 have traded down in the last 30 days (or since pricing) and 10 have traded up. The average performance over that period is (14.6 percent). While tech IPO investors have made just shy of $420mm buying tech IPOs year-to-date, half of these deals are currently below issue and the bulk of that performance has been driven by just two deals. If we take the gains of just those two deals we have $610mm with $190mm in losses for the aggregate of the remaining 20 deals.

So what kind of deals are doing well? Three variables stand out: 1) category leaders are outperforming, 2) deals with top line growth greater than 20 percent are outperforming, and 3) China is underperforming.

Photo courtesy: Instagram user, Kate8

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While much hay in investment circles has been made over “the death of the IPO” and the emergence of the M&A as the future end game for venture capitalists, Gurley doesn’t see it that way at all.

It’s true that household-name, blockbuster internet IPO’s have been on the decline since the first dot-com bubble. Meanwhile, for much of the past decade, big players like Google, Apple and Microsoft have been gobbling up companies at a ferocious pace. The market  naturally came to rely on mergers and acquisitions.

But these public giants are not making the large-scale acquisitions they once did. Conversely, says Gurley, the IPO market is already showing healthy signs of delivering. He looks to recent successful public offerings such as Green Dot, Opentable, Ancenstory.com   and Solarwinds to name a few. Meanwhile, companies like Kayak, Groupon, HomeAway and others are expected to hit the public market soon.

For Gurley, today’s high-profile LinkedIn IPO should put to rest any lingering belief that the IPO window is still slammed shut– regardless of how the stock performs in the future.

“There has been this malaise in the valley that the IPO market was dead,”  Gurley says.” The last remaining naysayers will finally have to put that to bed. For some people, today will be a wakeup call, it has to be.”

Public investors, like the buyers of mutual funds, are craving IPO’s for the access to growth they represent. ”The buy side of the market has been desperate for more product,” Gurley says.

But from the startup side, the reticence to go public is still hanging over the bay area like so much fog. Gurley and others argue Facebook founder Mark Zuckerberg’s famously coy attitude towards an IPO has helped fueld the perception that going public is a buzz kill.

“There is still a strong sentiment among many people in Silicon Valley that’s its much better to stay private if you can,” in order to keep total control of  the company and avoid the hassles of  shareholders to worry about, said Mike Volpi, a partner in the London office of Index Ventures.”Obviously, Mark Zuckerberg is a strong influence.”

Gurley elaborates: “Zuckerberg is a popular and well respected figure, so his decisions hold weight. But most companies aren’t Facebook,” he says. And now, with the market primed for more big ticket IPOs, the following  potential IPO candidates won’t be able to hide behind the idea of a market not ripe for their arrival, he said.

Still, after today’s valuation, Gurley also cautions the market from getting over eager and throwing more dollars at future offerings than they are worth.

LinkedIn is unique asset because it has no real competitors, very heavy barriers to entry, high profit margins, completely organic traffic growth with little in the way of marketing. It also has no dependencies.

“It doesn’t live on the back of Facebook, Google, Microsoft,” he said.

Gurley isn’t the only venture capitalist who predicts an IPO tipping point as a result of recent activity.

Manu Kumar, founder of K9 Ventures, compares the LinkedIn IPO  to the Netscape IPO “before Bubble 1.0 or the Google IPO post-Bubble 1.0.” He thinks LinkedIn could set the stage for other companies that are sitting on the edge of filing for their own public offering. Meanwhile,  the liquidity created by these successes (either in the public market or in the secondary market) will hopefully  increase the amount of money flowing into the startup ecosystem.

Of course, Kumar should have a great affinity for LinkedIn. The co-founder of CardMunch sold his startup to LinkedIn in January of this year.

“The startup eco-system has been anxiously awaiting for another beacon and another indication that things are live and well,” he said. “The excitement around the LinkedIn IPO has the potential to do just that. Kind of a “we’re back” signal to startup entrepreneurs who are sitting around trying to hatch their own startup dreams.”

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• Bill Gurley, general partner, Benchmark Capital
• Chris Hollenbeck, managing director,Granite Ventures
• David Horowitz, managing director, Comcast Interactive Capital
• Dan Beldy, managing director, Steamboat Ventures

The last event of the day was one of the most interesting, and the VCs were mostly positive about the prospects for online video.

“Five years ago very few people were watching video online,” said Horowitz, in response to a question about why the venture capital community should care about the video space. “Now you’ve got YouTube and billions of streams per month.  I think 10 years from now we’ll find other places to watch video.”

Also sounding a positive note, Beldy said that “even in a recession, broadband isn’t what people cut,” and noted that they’ll continue to consume online video despite financial challenges.

“When Hulu and Boxee got together, they woke up all the giants,” noted Benchmark Capital’s Gurley. “Since that day, everyone has been paying attention and people with billions of dollars are starting to march around.” Online video giant Hulu’s content was the most popular format on the open-source media center platform Boxee, when Hulu suddenly asked to have its content removed from Boxee. Since then, Boxee users have employed workarounds to continue to watch it. Gurley also alluded to Hulu possibly being forced toward a subscription-based model for its content, although his comment was vague.

There was a lot of talk about mobile applications focused on video. “One interesting thing about mobility is that I think it creates new viewing hours,” said Hollenbeck from Granite Ventures, which is backing makers of iPhone apps, among others. “That mobile device is with you all the time.”

Gurley also noted that technologies associated with computing are moving rapidly into digital entertainment devices. “Ethernet and some form of OS and a menu stack are being put in every TV, every DVD player, and every game machine,” he said. “Those of us who are old enough remember when that same thing happened on the phone stack. It’s going to be fun to watch. “

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