Capital is Good; the “Buffett Rule” is Not

The Washington Post published my editorial on the “Buffett Rule” — a proposal from President Obama to hike the effective capital gains rate on large payouts. I wrote that over time this would hurt technology startups because it increases the cost of capital and lowers the pool of available funds.

The editorial has provoked some vigorous debate. Reader comments in the Post have been mostly negative, which comes as no surprise given that the publication’s audience likely tends toward left-of-center readers and DC insiders. Here’s a quick roundup of responses:

  • Post columnist Ezra Klein responds to my editorial by ceding that my argument (i.e. the Buffett Rate is a capital gains hike that would diminish the investment pool for tech startups) might be correct, but then asserts we ought to tax the rich more anyway and concludes the logical way to protect tech is via a subsidy.
  • MotherJones’ blogger Kevin Drum covers a lot of ground in 3 paragraphs, saying higher capital gains rates don’t really impact investment, implying that there should be taxes on unrealized gains, and concluding that cap gains rates ought to be “maybe 30% or so” with no explanation offered as to why. Yikes.
  • Over at the Heritage Foundation, Mike Brownfield writes that the experience of California further serves to enhance my point. The Golden State, he notes, has relied heavily on taxation of the wealthy for revenue, and as a result has experienced wild boom-or-bust swings depending on the stock market.

My editorial stands on its own, and I don’t see a reason to amend it other than to point out that it’s a case study of the tax proposal’s unintended consequences on one industry. But a broader macro-economic analysis of Warren Buffett’s idea leads me to the same conclusion. Why? Because of several broad and simple principles:

Capital is good. Our country needs capital. Capital makes the economy grow and allows businesses to start and expand. All the political rhetoric is about taxing “millionaires” and “billionaires,” but the proposal really is about taxing capital. Passing this plan means that more capital will be taken from the (productive) private sector and given to the (unproductive) public sector.

Capital is fluid. National capital gains rates do not exist in a vacuum. If rates go too high, capital will leave our country in search of more fertile ground. Our nation’s 15% federal rate is the 4th highest of G7 countries (according to a 2009 study), and many developing countries have rates around 0%. It’s hard to conclude that our rates are too low when benchmarked globally.

Capital is property. What’s getting lost in the debate is that this discussion centers around seizing private property. Politicians and pundits engaging in “sticking it to the fat cats” rhetoric seem almost gleeful about taking away capital gains. While taxation is obviously legal, it ought not be flippant.

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Who’s bigger than Mark Zuckerberg? Matt Drudge, that’s who

Matt Drudge is still the king of the hill when it comes to online news. From my new GigaOM editorial, Why Matt Drudge Still Beats Mark Zuckerberg:

Facebook is closing in on 700 million users, but according to a new study by the Pew Research center, the Drudge Report sends more than twice as much traffic to the nation’s top news sites…

Forget the wisdom of the crowd. When it comes to online news, Matt Drudge is the one friend that news outlets really need to have.

Given how news outlets have struggled to adapt to the rise of the web, this should make Matt Drudge a hero. He’s sending outrageous amounts of traffic to traditional news outlets, giving them a chance to monetize their professionally generated content. But if you mention Matt Drudge in the tech world, the best you can hope for is a smirk.

I go on to make the case that Drudge deserves credit for being a truly great web pioneer, and that others online news entrepreneurs who’ve had big pay-days (such as Mike Arrington and Arianna Huffington) owe a debt of gratitude to the trail blazing Drudge, who helped change the way we consume news.

BusinessWeek Article on Private Company Valuations

I’m quoted and CapLinked is mentioned in this Bloomberg/BusinessWeek article on private company valuations. The article quotes a study documenting how secondary market valuations of VC-backed tech companies have risen a whopping 54% since June.

I’ll save musings about whether this is a potential asset bubble for another day, but I will add a clarifying comment to my quote in the article. Regardless of the valuations, companies such as Facebook, Zynga, Groupon, LinkedIn, etc. are excellent companies. If this were 1999 or even 2005, I think most of them would be publicly traded now. But given the current business and regulatory environment, they’re choosing to stay private.

GigaOM editorial: “Groupon’s Rise and eBay’s Decline”

Last week GigaOM published my editorial contrasting the rise of Groupon and the long, slow decline of eBay. I made the case that the poor economy–which has been a key driver behind Groupon’s growth–should have benefited eBay, as well. Why not?

The reasons for eBay’s stagnation come down to leadership. During former CEO Meg Whitman’s tenure, the company’s culture became increasingly bureaucratic, and improvements to the site became few and far between. eBay hiked fees aggressively while doing little to improve its user experience. The company misjudged the threat posed by Google’s advertising network, which effectively decentralized ecommerce by making it viable for small businesses to sell directly from their websites. Also, as my former PayPal colleague Keith Rabois asserted, eBay started out as a fun, social ecommerce site but it failed to grasp the advent of social networking.

Click here to read the rest of my piece.

How PayPal Can Kick Facebook’s Butt

One day after Facebook casually announced that it had eclipsed the 350 million user mark, I’m going to revisit the question of who will succeed in developing the dominant Web 2.0 payment system.

In my previous post, I made the case that PayPal was better positioned than Facebook to achieve this, a position I stand by even in light of the latter’s staggering growth. As I noted, there are four reasons why it will be difficult for Facebook or any other competitor to unseat PayPal: 1) payments networks are incredibly hard to build, 2) payments are not a core competency of most companies so they’ll struggle to deal with the complexities of the market, 3) non-fiat currencies are a hard sell to consumers, and 4) a Web 2.0 payments network would have the most value if it’s also compatible with real world transactions. All of these points (especially the last one) suggest that PayPal is in the driver’s seat.

But being in the driver’s seat doesn’t mean you’ll cross the finish line, much less take the checkered flag. If PayPal wants to become the Web 2.0 payments network of choice, it has a lot of work to do. Let’s take a look at some of the strategic measures it would need to pursue.

First, PayPal needs to foster an ecosystem around it that engages developers, expands its influence, and decentralizes innovation. Fortunately that’s what the company has taken strides to do recently, with the PayPal Innovate09 conference and the launch of the PayPal X Developer Network site. So it looks like the company is enthusiastically throwing its support behind its API, a feature my former colleague Dave McClure was calling for back in 2002 when he was PayPal’s “director of geek marketing.” So the good news here is that PayPal is making strides to emulate Facebook and Apple, who’ve already reaped the benefits of an army of third party applications, but it still has a long way to go. Getting developers to further integrate PayPal into games, virtual goods, and other social applications is key to dominating Web 2.0 payments. Innovative companies like Payvment that are using the API deserve the company’s support—and maybe even some venture funding from PayPal. Google does it, and it wouldn’t be hard for PayPal to allocate a few million dollars from its annual cashflow into a payments-focused venture fund.

Second, PayPal needs to expand the types of payments its core functionality services. Currently, PayPal’s “send money” functionality lets you classify transactions as goods, services, and eBay items. Clearly this is insufficient for the Web 2.0 universe, where content or simulated goods are often the center of transactions. But the need to expand payment types goes beyond just slapping a few new categories into a radio box—PayPal needs to explore making payment types user-defined. If a social network wants to sell stored value units (e.g. how Slide charges “gold” for premium Superpoke actions) then PayPal needs to accommodate them. And there’s no way to accommodate the limitless ideas of social entrepreneurs except by allowing for user-defined payment types. But this should be part of the core functionality available to all users on the main site through both send money and website payments, not something that depends on developers building into third party apps.

Third, PayPal needs to make a vigorous effort to allow users to export their eBay Feedback and PayPal reputation scores out of the eBay marketplace and onto anywhere they’re needed on the web. The reputational information that eBay/PayPal has collected on its users’ behalf is hugely valuable—and under-leveraged. Reputation isn’t too important for many social activities like re-tweeting or even deciding who to friend on Facebook, but when money is involved that dynamic changes. If “social” payments are to become a significant part of ecommerce, they can’t be confined to transactions between friends. Counter-party reputation will help instill confidence and empower this form of commerce, and the information available to PayPal/eBay is something that Facebook, Amazon, and Google can’t match.

(Brief aside: I’ve long been an advocate of eBay liberating Feedback scores from its site and allowing users to port their reputation elsewhere on the Web, including homepages, blogs, and social profiles. Back in 2003, after eBay acquired PayPal, I informally pitched the idea of exporting Feedback to my new colleagues on the eBay side of the company but it failed to gain traction. I’m sure that was in part due to my own communication deficiencies, but I also encountered some “we don’t do anything to cannibalize eBay’s core marketplace” pushback. With their marketplace stagnant and PayPal acknowledged as the core driver of eBay’s future growth prospects, I doubt the dynamic would be the same today. Plus, eBay CEO John Donahoe and PayPal president Scott Thompson both seem to realize how important PayPal’s growth is to the future prospects of eBay Inc.)

Fourth, PayPal needs to enable users to tweet payments. The mechanism for sending money via Twitter could be pretty simple, and it’s important enough to be part of PayPal’s core functionality. To do this, PayPal will need to let users link their account with Twitter, something their users have already been trained to do by linking PayPal to their eBay account as well as banks and credit cards. Some form of verification would probably be required; the hurdle needs to be a bit higher than what it takes to synch up third party apps like TweetDeck due to security concerns. One way to do this would be for PayPal to send a unique code to a user’s primary email address, which they then have to copy into a direct message on Twitter to @PayPal.)

Once this is set up, tweeting money would be easy. I think the simplest way would be to send a direct message to @PayPal followed by a simple syntax that includes the recipient’s Twitter username, the amount, and an optional note. Using a DM to convey the send money instructions to @PayPal would preserve privacy for both sender and recipient. If the recipient has already linked his PayPal and Twitter accounts, he would then get a DM from @PayPal confirming that he’s got cash. If the accounts aren’t linked, he’d get tweeted a notice from @PayPal that he’s got cash (but no specifics on the transaction since tweets aren’t hidden), along with a shortened link to take him to PayPal’s site to claim it by linking accounts. This flow would be simple and elegant, and once the accounts are linked people could tweet money without having to login to PayPal’s site.

You might be asking, if the goal is to become the Web 2.0 payments gold standard, why focus on Twitter first, as opposed to Facebook? I think Twitter is the better forum for PayPal to go after right now for a couple of reasons. For one thing, integration would be easier given the open nature of Twitter’s platform. Also, the overlap in the Venn diagram of PayPal (78 million active users) and Twitter (93 million active users) should be close to 100%. Twitter’s users still skew toward the tech savvy and early adopters, whereas Facebook’s 350 million accounts are obviously less tech savvy on average because they look more like the world as a whole (i.e. there’s a lot of Baby Boomers using Facebook).

PayPal should have a significant portion of Twitter users linking their accounts within 1-2 quarters, which would give it a strong launch pad for going after the rest of the Web 2.0 universe. Think of what third party developers could build after users begin to link their PayPal and Twitter accounts on a serious scale. Also, capturing payments for the majority of the Twitter user base would also give Facebook a major disincentive to block PayPal from its site, which (like eBay before them) is a temptation they’ll probably face once PayPal starts playing in their sandbox.

This is by no means an exhaustive list of the steps PayPal would need to take to secure leadership in Web 2.0 payments. We haven’t even touched on pricing, much less Facebook integration. But it’s a good start.

Who Will Win the Web 2.0 Payment Wars?

Call it micro-payments, social networking payments, virtual currency, or whatever you like, but speculation is heating up as to who will develop a service that addresses Web 2.0’s payment needs.

PayPal claimed this mantle for the first incarnation of the internet. As I detailed in The PayPal Wars, when Peter Thiel, Max Levchin, David Sacks, Reid Hoffman, and the rest of our executive team made the decision in January 2000 to build our payments network on top of eBay’s ecosystem of buyers and sellers, we outflanked our competitors and identified the path that would let us scale to profitability. In doing so, our startup beat out Yahoo, Citibank, and even eBay itself (which jointly owned Billpoint with Wells Fargo) to become the de facto standard for selling goods online.

But the payment needs of the social web are different. Goods are generally virtual or content-related, and the transaction amounts are often small. (For example, Slide charges a $1 for premium SuperPoke actions, or gives you unlimited quantity for $4.99 per month. Contrast this with the $50 average transaction price we saw at PayPal.) Also, any payment solution would need to be tightly integrated with the social network it’s serving.

The need for social payments is growing. Case in point, Dan Gillmor asserts on his blog Mediactive that YouTube Direct (YouTube’s platform to let news organizations collect user-submitted videos) would also benefit from a payment system. Dan points out that this would allow content providers to reward their followers for providing them with monetizable content.

A couple of Twitter-centric payment services have already sprouted up; Twitpay and Twippr both leverage PayPal’s platform to allow you to tweet money. (See this Squidoo post for a helpful comparison.) TipJoy, another company that specialized in Twitter payments, is shutting down.

Of course, it’s Facebook—the most important social network site—that’s attracting a lot of attention in the payments discussion. Mashable’s Pete Cashmore writes that Facebook itself could become the micro-payment service of choice for content providers. Noting the proliferation of virtual goods on the social networking system, as well as the many media companies now participating in Facebook Connect, he concludes that Facebook (which has a beta virtual currency in beta mode) has a better chance to build this platform than PayPal, Google, or Amazon.

TwoFish’s Lisa Rutherford provided a nice overview of the marketplace a few months ago for VentureBeat. She saw PayPal, Amazon, and Google as potential players, but seems to suggest that it’s unclear if Facebook will make a full court press to dominate this space. However, it looks like that’s exactly what Facebook is doing; I’m told that they recently hired a couple of highly respected ex-PayPal guys to work on their payments team.

Facebook is certainly formidable. Nonetheless, I still think PayPal should own this space. Here are some reasons why:

First, a payments network is not easy to build. Even if you have an existing network of users that you can leverage, the back-end is a lot more difficult than a content-based service.  Fraud risk, funding costs, and customer support are all major factors that we underestimated in terms of complexity or cost as PayPal was scaling. As I noted in my book, PayPal was bleeding $10 million per month back in 2000 while we struggled to fix our business model, and that was before the company had scaled to any significant size.

Second, just because a company is good at its core business doesn’t mean it will be good at payments. Facebook is an amazing company, but that’s no guarantee that it can leverage its social leadership to build a scaleable payments network. Google hasn’t been able to do it with its Checkout feature, and despite the elegance of One Click, Amazon has never been able to get much traction with payments off its own site. If a competitor has a better product, users will opt for the competitor. The case of eBay’s own users refusing to adopt Billpoint in favor of PayPal illustrates this.

Third, non-fiat currencies aren’t an easy sell to consumers. Ask Flooz. Ask Beenz. These two early, would-be PayPal competitors occupy spots #2 and #3 on Business Pundit’s “25 Internet Startups That Bombed Miserably” list. (If not for “Startup.com,” they might’ve ousted GovWorks from the top spot.) While many people think that the time is ripe for a virtual currency, there’s no hard evidence of demand for a system of value not based on fiat money. Cash is still king, and that’s a major obstacle for companies like Facebook opting to build a virtual currency.

Fourth, the implicit assumption that a Web 2.0 payments network doesn’t need to be compatible with transactions happening in the real world is false. Backwards compatibility is important for any platform—just ask an Office 2003 user who’s received a .docx file. The utility of a payments system is immensely greater if the network encompasses not just the up-and-coming world of social/virtual transactions, but also some chunk of the $30 trillion in annual consumer payments worldwide. PayPal already moves $2200 USD per second through its servers; that’s a nice head start.

Building a payments network is difficult, and it’s not clear that Facebook or any other competitor will be able to leapfrog over PayPal and build the defining platform for Web 2.0. However, if PayPal wants to seize leadership in this space, it has a lot of work to do. We’ll explore that in a future post.