Drug Dealers Give Investing Advice

By Wayne Mulligan, on Thursday, June 4, 2015

A massive market bursting with profits...

Aggressive competition...

And an entrepreneur who’s putting it all on the line.

You might think I’m referring to corporate warfare—but I’m not:

I’m talking about the world of drug dealing.

But the interesting thing is this:

By observing one world, you can learn what it takes to succeed in the other.

“Google Crack”

The roots of this idea began germinating for me years ago, as I got lost in the fictitious TV worlds of “The Wire” and “Breaking Bad.”

And I was reminded of this idea last weekend when I read an article in Business Insider called “The Race to Zero."

The author was commenting on the price wars currently being waged in the “cloud-computing” space.

You see, companies like Amazon and Google have been offering more and more free storage space for their cloud-based services—for example, free storage for big files and photos.

Their goal is to use these free offerings to attract customers, and then “up sell” people into paid services in the future.

As Walter White from “Breaking Bad” taught me, this is similar to how drug dealers give new customers a “taste” of a drug for free...

Walter knew that customers would come back for more once they were hooked.

A Start-up Strategy?

For a deep-pocketed company like Google, attracting customers by giving away services for free is a smart strategy.

And Google was able to afford sustained losses until it reached “critical mass”—then it was able to convert some of its users into customers who paid for “premium” services like additional security, spam protection, or custom email addresses.

But Google wasn’t the company that brought this “street” strategy to the cloud-computing battlefield:

This strategy was first used by a tiny start-up...

Box Out The Competition

The start-up I’m referring to is the cloud storage company, Box (NYSE: BOX).

Although it’s now publicly traded, Box began life in 2005 as a tiny start-up.

Even from the beginning, Box used the “drug dealer” strategy: it gave away “samples” of its product to gain market share.

From its humble beginnings, Box grew its sales in 2014 to more than $200 million—despite the fact that the vast majority of its users don’t pay a dime.

Now, keep in mind:

If a start-up intends to leverage this strategy, it will need to raise multiple rounds of financing to support it. Box, for example, raised more than 10 rounds...

But it got started with the type of small funding round that you’ll see on Crowdability—in Box’s case, it was a $350,000 round of “seed” funding.

And those early investors did very well:

When the company went public, it’s estimated that they made a 4,780% return.

What Makes it All Possible

But beyond the capital that’s required to make this strategy possible, there’s also a technology concept:

It’s known as “Moore’s Law.”

Moore’s Law states that computing power will double every 18 months or so—and generally this has led to computing costs getting cut in half in the same timeframe.

With decreasing operating costs, plus the ability to subsidize losses by raising more capital, a start-up can effectively use “free” marketing strategies to capture and then dominate a market.

So when you’re evaluating an early-stage investment opportunity, don’t run for the hills if you see that a company isn’t currently charging for its services.

In fact, with certain companies, you should be encouraged by this strategy.

Just be sure the following two factors are in place:

  1. The company plans to eventually charge for its services
  2. The company is providing a digital product or service

You see, Moore’s law doesn’t apply to physical goods—physical goods don’t have the same cost efficiencies and productivity increases as software products.

Evidently, these limitations of physical products are why Walter White had to get his customers hooked right away...

Maybe in another world, he would have started a technology company.

Happy investing.

Best Regards,
Wayne Mulligan

Founder
Crowdability.com

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