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Returning Money to Investors: How to Calculate their actual return

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You’re giving them money, but how do you calculate their actual return?

Your investors give you money. You give your investors money. In the end, they want a good return on the money they’ve given you. How do you calculate the return you’re providing? The number you’re after is the “internal rate of return” (IRR) of the cash flowing between you and them. Most spreadsheets have an IRR function you can use for this calculation.

Step 1: Identify the cash flows

First, lay out the cash flows as a series of numbers. Use negative numbers for cash you receive from the investors. Use positive numbers for cash the investors receive. Each number should represent the same time period.

For example, if investors give you $1,000 at the start of January, and you give them $50 at the start of February, April, and June, and also return the $1,000 principal in June, the cash flows look like this:

 
A
B
C
D
E
F

1
Jan
Feb
Mar
Apr
May
Jun

2
-1000
50
0
50
0
1050

Step 2: Use the IRR function to calculate the rate of return.

If you’ve typed the above into a spreadsheet, the formula to calculate the rate of return is:

IRR(A2:F2) which equals 3%

Example #1: A bank loan

A bank loans you $10,000. They expect $500/month payments for 6 months. They want principal repaid at the same time as the last payment.

 
A
B
C
D
E
F
G
1
Jan
Feb
Mar
Apr
May
 Jun
Jul
2

-10,000
500
500
500
500
 500
10,500

IRR (A2:G2) = 5%

Example #2: Equity investment

Investors put in $50,000 in preferred stock. They expect a $1,000 dividend each year for four years. On the fifth anniversary of their investment, they expect the company to be acquired, with their stake worth $100,000.

 

A

B

C

D

E

F

1
Now
Y1
Y2
Y3
Y4
Y5

2
-50,000
1,000
1,000
1,000
1,000
100,000

IRR (A2:F2) = 16%

What cash do I need to provide them to produce the return they demand?

Often you know how much you want investors to invest, and they are demanding a certain rate of return. What cash flows do you need to provide to give them that rate of return?

If they provide $100,000 and demand a 40% rate of return per year, that means you’ll have to pay them $40,000 each year. If you agree that they get their money in a lump sum when the company goes public, then the 40% compounds. The calculation is easy—the total due each year is the previous year’s total plus the interest (40%):

Year

What you owe them
Now
 $100,000
1
 $140,000 (100,000 + 40%*100,000)
2
 $196,000 (140,000 + 40%*140,000)
3
 $274,400 (196,000 + 40%*196,000)
4
 $384,160 (274,400 + 40%*274,400)
5
 $537,824 (384,160 + 40%*384,160)

If you estimate the company will be worth $5,000,000 at the end of the fifth year, then the investors will need to own 10.8% of the company ($537,824 / $5,000,000) in order for them to get their 40% return.

Get a Life While You Still Have the Chance (it's easier than you think)

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From my newsletter of December 2000

I’ve spent the last four days bedridden, recovering from oral surgery, unable to eat, and barely able to think. It’s been wonderful. It really underscores the value of time away from work. And life balance is possible without major surgery. You just have to know how…

Most importantly, you must decide that having a life is a priority. Many claim they value balance—they just have to work late this once… Make the decision and commit to it. Don’t wait for a brush with death to decide. My friend John needed a mid-30s heart attack to slow him down. For me, it was caring for a dying parent. Be good to yourself. Decide on your own to have a life!

Time is precious; no amount of money can buy back time. Set firm boundaries on the time you spend at work and home. Within those boundaries, only take on as much as you can do in that time. If you decide you will work eight hours each day, turn down work that will require a ten hours a day.

Use the 80/20 rule: you get 80% of your results from 20% of your time. Track how you spend your time, identify the tasks that produce the most results, and orient your work around those high-leverage activities. Use the extra productivity to pay someone else to do the low leverage activities.

Respect your boundaries. When you’re playing, really play. When you’re at work, really work. Your unconscious mind will know if you’re cheating—if you truly honor your commitment to yourself, you’ll be surprised how much more you’ll get done in both places.

If you find yourself having business thoughts during free time, buy an 89-cent notepad & pen and carry it with you. Jot down those thoughts when they happen, and go back to playing. When you get to work, start by reviewing your notepad for critical ideas.

Read a (fun!) book, go on a trip with your family, or see a movie for pleasure at least once a month.

Assignment: identify one high-leverage activity you do that produces lots of results. Identify one low-leverage activity that takes time but doesn’t do much for you. Arrange to have the low-leverage activity taken care of some other way, and use the time you save to do more of the high leverage activity.

Making Space for Success: Controlling Clutter

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Clutter kills our dreams. It fogs our vision. Cleverly disguised as temporary convenience ("I’ll just put this here … for now"), clutter undermines more progress than TV, soft-money campaign contributions, and badly designed web sites put together. Who can be a visionary leader, when vision is obscured by a stack of magazines waiting to be read, twenty signature pages to forgotten contracts, a file folder of "time-critical stuff" dated 4-17-1998, and an e-mail inbox the size of Texas?

For many of us, getting a handle on clutter is remarkably freeing…

This article is continued in “It Takes a Lot More than Attitude … to Lead a Stellar Organization!" Click here to purchase.

Stever's flame on why ASPs, Web 2.0, and everything new is really just old again

It’s always something; if only it were something new.
Stever sounds off about ASPs

Inc. Magazine, April 2000, Alessandra Bianchi declares on page 29, “The entire software industry is about to be turned upside down [by ASPs].” ASPs, for those of you who don’t know, are Application Service Providers. They provide central services on their computer, which you run from your machine, usually through a web browser.

Hi, Alessandra. You must be young, unfamiliar with the computer industry, and
probably didn‘t think to talk to anyone over 23 while researching your story. Yawn. I continually wonder whether I was as myopic and self-absorbed in my 20s as the current generation of 20-somethings seem to be (at least in the Internet start-up world)? Probably not. But I’m working on becoming that myopic and self-absorbed now. Better late than never.

So, Alessandra, come and sit upon my wizened knee. Let me share with you a bit of perspective from 23 years in the high tech industry. No, really. Come on. There’s a good little reporter. Please just humor an old fogey for a moment…

The idea of running software on a central machine and having it delivered to distant desktops has existed for decades.

In the 70s, it was called time-sharing, and featured “dumb terminal” (text-only) distant desktops.

In the 80s, it was called client-server, and featured “smart” distant desktops (entire computers).

In the 90s, it is being called ASP, and features stupider distant desktops (entire computers whose processing power is ignored except for one poorly-written Web browser).

There’s a lot to celebrate about the last three decades of computer science, but the idea that we have a new model for software services distribution isn’t one of them.

There are lots of good reasons to run a program on a central server:

  • You only need to upgrade the server, and all the users get the change.
  • For a big ole application, only your server needs to be huge. Your client machines can be dinky, inexpensive doo-hickeys.
  • Any data stored centrally on a server can be backed up by the server’s staff.
  • You can pay-as-you-go, so for expensive programs you rarely use (e.g. the non-professional designer who uses Photoshop once a year), it saves you money.
  • The server can collect tons and tons of personal data on you by watching everything you do with that application, and the ASP providers can sell that information to marketers and terrorists so … um, whoops. That’s not a reason to use a central server. Never mind.
  • … and that’s about it.

There are lots of good reasons to run a program on your desktop:

  • You get to control upgrades, so some stupid unanticipated upgrade doesn‘t tank your machine and your productivity as you desperately try to untangle the unwelcome new interface, or the mush that a bug in the new upgrade has made in your locally stored data.
  • You don’t have a single point of failure. If you use an ASP for a mission-critical application and it crashes (or anything along the path between you and it crashes), your work stops until the breakdown is fixed. If your entire company uses a centralized server, a break in the network or the server can stop your entire company for a day. That costs more than just the cost to fix the system; it’s essentially your entire company’s output for the time it takes to fix the breakdown! (See The Goal for details about that last one…)
  • It runs faster. Period. The Internet, especially, is dog-slow. And the slowness can happen anywhere along the path between you and your host. With a desktop, you know how to speed it up: buy a new disk and processor. With a network-based program, there may be no way to speed it up.
  • It’s pay-once, so for programs you use often, you don’t have to worry about being reamed by deceptive pay-as-you-go fees that seem cheap until you realize that over the next two years, you will spend ten times more on the software rental than you ever would on a piece of shrink-wrapped software.
  • You can backup your data yourself, so when the central database server has a disk-destroying crash and it turns out that the support staff wasn’t actually making those backups they had promised, you won‘t lose a decade’s work.

Once, and only once, I used Yahoo calendar for a week. My ISP was having connectivity troubles right as I had to rush out to a meeting and had forgotten where to go. Alas, my Yahoo Calendar didn’t leave me yelling “Yahoo”—it left me yelling “G*d f**king damnit!” Which wasn’t nearly as much fun.

If you like the whole ASP model, however, then please indulge. You feel like you’re out of control technologically, now? Just wait. Hee, hee, hee. And please—send me your now-useless PC, since I really need one to use as a print server…

Update in mid-2010: Now we have “software as a service (SAAS)” and “cloud computing.” Guess what? Same stuff, different day. Everything old is new again, only “old” in this case means two years old, not two decades old.

Organize Your Life With 2 "To Do" Lists

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It’s been a pretty busy month, and I’ve been swamped with so many TO DO items that post-it notes, scraps of paper, napkins, and dozens of other scribbled “urgent” tasks have been covering my desk. My Palm Pilot TO DO list terrifies me. Every night I prayed, “Grant me freedom! Let my Palm’s recharger mysteriously run out of power.” My prayers were answered in the book The Organized Executive by Stephanie Winston.

Stephanie suggest a method that’s working great for me:…

This article is continued in “It Takes a Lot More than Attitude … to Lead a Stellar Organization!" Click here to purchase.

Don't Make the Same Old Mistakes—Make New Ones

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Failure doesn’t guarantee learning, just the chance to learn!

As the dot-com death spiral continues, a friend said, “it was painful, but I learned a lot.’ Eager to learn without suffering the pain myself, I ask, “What did you learn?” He lists five lessons, all pretty obvious—for just $100 million (none of it his) and four years. There’s gotta be a cheaper way. We say we learn from our mistakes, but few of us really extract quality learning from our experience. If you’re going to make mistakes, make them thoroughly, and learn well from them.

Schedule time for learning. Don’t assume it happens automatically; it usually doesn’t…

This article is continued in “It Takes a Lot More than Attitude … to Lead a Stellar Organization!" Click here to purchase.

Five Great Ways to Tank Customer Loyalty Before It's Begun

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Click here to download this article in PDF format.

Don’t the best relationships begin with tricks, manipulation, and deception? You’d think so, from the way some companies treat new customers. We all want strong relationships; they lead to loyalty and word of mouth. The buzz builds, and soon you’re thriving. Customers stay because they love us (who can compete with love?) and Life is Good. As with any relationship, beginnings are fragile. Missteps up front can set the stage for arms-length engagement forever. Here are a few mistakes you’ve either made or been victim of, and what to do instead to have the best chances of keeping your customers.

Mistake #1: Collecting Customer Information Before Establishing Customer Loyalty

I needed a quote from an article in a famous business daily newspaper. The business daily was happy to let me search their last month’s archive, but first I had to register, giving them personal information up front. A common practice, but how stupid. Sure, they want to market to me. But didn’t I come to their site on my own? They have my awareness already. The free offer isn’t so free. They want contact info in return. Why would they want my info, except to send me junk mail? Oh boy, I can hardly wait!

If you promise a free offer and want to capture customer information before you deliver, make the information capture optional. Most people will be happy to share their contact information with you. After all, they’re there because they hope you’ll solve their problem.

Strong relationships are built on understanding each other’s needs and filling them so well both parties want to stay. At first contact, fill their needs first. Then you’ve earned the right to ask further questions and explore how to get what you want.

This is an introduction, so ask only for information needed to deliver the free offer. If you’re mailing something, you’ll need a person’s mailing address. Ask for it. But stop there. Keep questions respectful. Quizzing someone about their household income before you know them is tasteless and rude, no matter how much you like voyeurism.

If you ask personal questions before you’ve earned the right, people will lie. Even about phone numbers. When a stranger asks for your number and won’t take “no” for an answer, you give them a fake one. And probably a fake name. And an address in Poughkeepsie. Spending a little time to earn trust before asking is the best way to start any relationship.

Mistake #2: Making Customers “Opt-out” of Loyalty Programs

Unfortunately, the quote wasn’t in the one-month archive. But to search last year’s archives required signing up for a free two-week trial of the publication. My trial was active within a few hours. After finishing the search, my day moved on and the incident was forgotten. Two weeks later, a receipt arrived from nowhere informing me my credit card had been charged $30 for “change in account status.”

“Try for two weeks and cancel before we start charging” is a great way to generate active hostility. The free trial is nice. The burden of having to remember the trial expiration is not. If a customer intends to cancel, hoping they forget the due date and get tricked into taking your product isn’t going to inspire fierce devotion and a desire to purchase more. At best, they’ll feel like they screwed up. At worse, they’ll blame you. Do you really want people choosing between shame and anger as how they feel about your company?

The same thing happens with opt-out marketing lists. “Check here if you don’t want us to share your personal purchase data with everyone from General Electric to David Letterman.” Face it: people (except a few fanatical direct-mail marketers) don’t want more junk mail, no matter how profitable it is for you to send it. Making them “opt out” demonstrates that you act only in your own interests unless a customer takes the initiative to have their needs considered.

The daily business site did an especially bad job, because the first reminder of the trial expiration was the charge receipt. What’s worse, the site gave no instructions for canceling a trial before it became real.

If you’re going to offer people a trial that turns into commitment, warn them before the transition. Otherwise, people convert by fiat. If you’d rather have them convert out of enthusiastic satisfaction, spend the trial period giving them value, value, value. Teach them to use your product better. Give them tips about how many problems they can solve forever with just your product and a bag of odds-and-ends they can find around the home. Then let them know the transition is coming up, and only then start charging.

Moving from dating to marriage should require ceremony in any relationship. Sure, if you shack up together for a while, you’re married under common law. But make sure you check in together before it becomes real. Accidental marriage is no fun for either party.

Mistake #3: Not Planning for Separation (Loyalty isn’t always forever)

Well, there was no obvious way to back out of my trial. The “My Account” section of the web site let me modify my account settings and include all kinds of add-ons to my subscription. There was no way to cancel, however, nor did anything in the help file mention canceling. It took a half-hour on the web site, plus calls and emails to customer service before the charge was removed.

What were they thinking? “Gee, if we make it hard to cancel, someone who wants out will just knuckle-under and keep paying us forever?” The marketing genius who came up with that one should be put out of their misery. Making it hard to cancel won’t stop a customer from leaving; it just adds frustration. People leave for all kinds of reasons. They might come back. Don’t guarantee their last memories of you are of trickery and manipulation.

And make it easy for customers to leave and return. Many relationships are paradoxically strengthened when the parties involved feel as if they have the freedom to leave.

“If you want a customer very much, let them go free. If they come back, it was meant to be-treasure them forever.”

— Random New Age Quote

“…If they do not, sell their name and address to your direct marketing partners, because at that point, you have nothing to lose.”
— Marketing addendum to Random New Age Quote

Mistake #4: Making bad first impressions.

While waiting for my subscription refund, I bought new backup software. Installing it took half an hour and then it wouldn’t run. Reading the fine print, it seems I was supposed to bring my system “up to date” before installing. In plain English: download 100 Mb of software updates from Microsoft and install them all. No way. Not until I can afford to go computerless for a week while my tech person fixes everything the updates broke. The backup software went back to the store, amidst grumbling over the lost time.

Those pesky customers. They buy your product, take it home, and expect it to work. When they find no batteries included with their new $180 MP3-player, they curse, scream, and run out to buy the $2 extra batteries. How unreasonable can they get?

When I worked at Intuit, we followed customers home and watched them struggle with our product from purchase until successful use. We quickly learned to streamline the purchase and installation until it was ran as smoothly as melted Velveeta on nachos . We identified everything a customer would need to use our product and make sure it was all included or clearly identified before purchase.

Trying and buying a product is your customer’s first impression of you. Orchestrate it carefully; first impressions count. It’s worth doing whatever it takes to make their experience a joy. It may mean more work for you, but if it gets you a customer for life, it’s probably worth it. We recently bought a manual lawn mower that assembled with no tools and needed a single sheet of instructions to master. We’ve already recommended it to friends. You can bet when it needs replacing we’ll stick with the same brand.

Remember when you picked up your spouse for your first date. Were your first words, “By the way, the car is out of gas. Here’s the gas can. Why don’t you run out and snag a gallon while I wait here with your parents?” Of course not. You are smarter than that when it comes to personal relationships. Be smart in business, too. Include the $2 batteries in your $180 MP3-player.

Mistake #5: Invading personal space

I signed up years ago for a marketing newsletter with a man rumored to be one of the most famous, successful marketing consultants of all time. Imagine my delight when I’ve received great offers directed to his “exclusive inner circle of personally important customers.” My delight was diminished just a bit by the letter having been addressed to “Dear Nospam-marketing@LeadershipDecisionworks.com.” Personal friends? Exclusive inner circle? I think not.

Just don’t do it. Computers may provide “mass customization,” but your customers know that. They own laser printers, too. Fake friendliness won’t impress them. If your letters aren’t hand-signed by someone whose name they know, they won’t believe for a moment that they’re any more special than anyone else. They just believe you have a good mail merge program.

If you waste your “Dear close friend” on people you barely know, you do a double disservice. First, you make it hard to make your true close friends feel special. How do you start the letter, “Dear close friend-no, I mean it this time, you really are a close friend”? I don’t think so. You also deliver the reek of insincere carnival con-man to your customers. They know they aren’t your close friend. Don’t insult them by presuming you can play off a relationship that doesn’t exist. If this is a new customer, don’t be afraid to admit it. After all, they’re under no illusions that you’ve been friends for life. Just say “Dear new customer, here’s a chance to meet your needs for marketing advice!” A little refreshing honesty can work wonders.

Honesty is the foundation for great relationships. Even if you can get away with pretending closeness where none exists, think twice. If the truth comes out, it could be worse than playing it slow to begin with. Just ask any pair of identical twins who pulled the dating switch-a-roo back in high school. It might have been fun for an evening, but once the truth came out, they found themselves suddenly single.

Business leadership is first and foremost about forging relationships. You’ll be most successful when you build those relationships to last. Customer relationships are only part of the story. You also have relationships with employees, vendors, and investors. The same principles apply everywhere: give good first impressions, answer their needs before pushing your own, respect their personal space, and make it easy for them to pull back to their own comfort level. It takes a bit longer than just charging ahead, but anticipation is, they say, the spice of life!

Tragedy Helps us Lead

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Terrorism can help us find our inspirational self

Like most people, the WTC bombing left me stunned, confused, and horrified. For the last three days, I’ve watched the news, listlessly done some work, and listened in shock to our national leaders declaring war. Today, I had another shock as I listened to the radio discuss an intercepted memo, leaked from an organization with members in countries around the world. The memo laid out the advantages to killing more than 20,000 foreign civilians. It wasn’t until the end of the news report that I realized… the company was Philip Morris, analyzing how much money early smoking deaths would save the Czech Republic in federal pensions.

As horrible as the WTC bombing was, I left lunch numbed by the behavior of our own countrymen. It is horrible to kill quickly, motivated by hatred and religious fanaticism. Is it somehow better to kill slowly, motivated by profit?

As businesspeople, we represent our country and our values to the rest of the world. Diplomats talk to other diplomats. Businesspeople reach everyone.

Whether you read my list as an entrepreneur, as an aspiring leader, or just as a bystander, take this opportunity to dig beneath your outrage. Beneath it all, you’ll find what you Stand For. Was your sense of security shaken by the bombing? Then you stand for Security. Were you filled with fear for your children, then you stand for Safety. Were you upset by the lives cut short? Then you stand for Leading a Fulfulling Life.

As a future leader, entrepreneur, manager, or human being, begin incorporating your values explicitly into your life. Stand For What’s Important. Ask daily how you can contribute to Security around the world. Question how you can do your part to help people be Safe. Help those around you Lead Fulfilling Lives. Whatever you Stand For, bring it into your life, every day.

You truly rise above yourself and begin to create a stronger, more powerful world when you operate from and act on your values. As horrible as this disaster has been, use the horror to find the good. Find your passion. Live it. Inspire those around you, and create a better world. There will always be those who bring pain to the world. Be someone who brings progress and advancement.

Best wishes,

Stever

Step up to Leadership in Times of War

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Click here to download this article in PDF format.

The war has begun. Times are scary. People are angry, frightened, uncertain, and need direction. For most people, uncertainty makes them feel afraid, anxious, and helpless. People just can’t go about their lives as normal. They may put on a brave face, but they won’t be concentrating, they won’t be committed; they’ll just be going through the motions. In the coming weeks, people will need leadership more than ever. Your opportunity will be helping employees, families, and communities keep their center and live their lives while the drama unfolds around the world.

Help manage emotions using empathy

First of all, let people vent. People need to talk about what’s happening to deal with the feelings. Some people need a lot of time to process strong emotion, possibly days or weeks. Others can get up and keep going after a day or two. There’s little to be gained by letting people wallow excessively in emotion, but listening to them empathetically can make a huge difference.

To listen empathetically, acknowledge the events that brought up the emotion and asking about the feelings. You aren’t seeking to understand or fix; just to be there with a person in their feelings. “When you hear war has broken out, do you feel afraid?” Let them talk. If they mention their family, follow up with: “When you think about the future, are you concerned for your children?”

The key is to inquire with genuine concern(1), but let them direct the conversation. Keep your attention on the events and the feelings, rather than getting sucked in to analysis or attempts to comfort. Don’t take sides! Everyone has strong feelings about the situation, and your leadership task is giving people what they need, not engaging them in political debate.

Whether their fears are grounded doesn’t matter; emotion is rarely swayed by logic. Just be there, emotionally. It may take 30 seconds or three hours, but you’ll see a physical shift when your listener has had enough empathy to start moving through their feelings.

Provide certainty by facing the truth

Once their immediate fear is past, people need to re-establish a feeling of certainty. You can’t give certainty about the world, but you can give them certainty about values, goals, and local concerns. Forget statements like, “Don’t worry, it will all be over in a week.” That may or may not be true, and they know it. Tell the truth, and give certainty in the form of a role model who sees the world clearly and still moves ahead with life: “We’re at war. We don’t know the outcome. We don’t even know the timeframe of the outcome. But we can take control of our own lives, here and now.”

Help people take control in their lives

After re-steadying, people will want to regain control of their lives. Find chances for them to take small, meaningful actions, maybe around work, but if not, then around home or community. If your town is like many, people may be afraid of terrorist attacks, yet towns may have few resources in place. For instance, here in Boston, a fire chief said yesterday that the fire department doesn’t know how they would find out about any attacks, except by listening to the radio. This would be a great opportunity to take a half-day off, go to Costco, and help people put together water supplies, dried fruit, etc. They could create a phone tree, and take a proactive hand in feeling safe. Just make sure you’re providing opportunities for people to have control over some aspect of their situation.

Shift attention to the positive future

Once the immediate fears are past, it’s an ideal time to shift people’s attention to the future they will be part of creating.

Start talking about future dreams. You’ll know their concerns by this time, so enlist them in speculation and brainstorming about the kind of future they would be excited about and committed to achieving in the workplace (or in the world!)

Help them take steps here and now to continue living their lives in the service of that larger vision. If your company is devoted to creating intimate lifelong banking relationships with your customers, start asking people, “What does this mean in the world as it’s unfolding? What can we do to make this come about?” But stay aware that this isn’t a planning exercise so much as a way to direct attention towards a bright future.

Ultimately, that’s the most precious thing you can offer your employees, your families, and your communities. You can’t promise a specific future, but you can promise a possibility of future greatness. You can help people take control in small ways, and move on from their fear and anxiety. Because the people around us need direction. They want someone they can count on. Be that someone. Provide the stability, empathy, and direction, and use the current crisis to forge a stronger community.

(1) One of the best techniques for empathetic listening I’ve ever found is called Nonviolent Communication, available at http://www.nonviolentcommunication.com. This article mentions two of the four steps of the full NVC technique. back to article

The Myth of Digital and Technology Convergence

Click here to download this article in PDF format.

I am looking at a full-page ad in the Wall Street Journal. Samsung Electronics Vice-Chairman Yun is proclaiming himself “An Ardent Promoter of Digital Convergence.” Run, don’t walk, to sell your Samsung stock. Because despite a decade or two of hype, digital and technology convergence just don’t exist … and they’re irrelevant.

When two products converge, so the theory goes, you end up with a combined product that is somehow “the product of the future.” We have vague images of this new combined artifact taking over the world. But let’s get concrete: name two product categories that have successfully converged. Now name two more. You probably can’t, because products grow by differentiating, not converging.

Once upon a time there was a Model T. It came in a variety of colors (black). It came in a variety of styles (one). Then some bright marketer realized, “Hey! I’ll bet Rich people would pay more for diamond-studded seats.” Thus was the upscale car was born. Color was added … and radios … and intermittent windshield wipers. The market expanded by reaching more people, and reaching more people means creating versions of the product that reach different market segments.

A Case Study in Digital Convergence: TV and VCRs Converge (NOT!)

Consider why the TV/VCR convergence never took off (if you currently own a TV/VCR combo, please accept on faith that you’re the only person in your town who does). TVs come in many sizes. They come with many features. The features set the price and desirability. My friend Kevin paid thousands for a surround-sound capable, high-definition plasma display TV, with picture-in-screen. I paid two-hundred dollars for a TV large enough to use as a table without ever removing it from its box. Since I really need a table, I’ve never bothered to discover its other features.

VCRs offer variety, too: super-fast motion, slow motion, freeze-frame, dubbing capability, remote control, on-screen programming, automatic bar-code programming, etc.

So what does the TV/VCR convergence look like? The manufacturers choose one model of TV, one model of VCR, combine them, and voila! The result appeals to the one market segment wanting those TV features and those VCR features—a tiny subset of the TV and VCR markets.

The converged product will always offer less variety than the individual products. To offer the same variety, the converged product would need to come in models offering all the combinations of the original products’ features. If there are five VCR models and ten TV models, it would take 50 different VCR/TV combos to give consumers the same feature combinations. Manufacturers would go nuts trying to create that many product lines.

Converged products are best thought of as a niche version of the component products. A TV/VCR combo is really a TV with an extra VCR thrown on. Or maybe it’s a VCR with a free TV. Either way, it’s a subcategory of both, not a separate category.

Converged Products are Hard to Use

People like easy-to-operate tools. Even if a combined product meets a market need, it will be harder to use than the originals. A personal digital assistant (PDA) / cell phone combo needs the controls of a PDA, the controls of a cell phone, and controls for the interaction between the two devices (for example, a new control telling the PDA to dial a phone number). Most VCRs can barely be programmed by people with a Ph.D.; converged devices have no hope of being easier.

In the mid-1990s, home computers came able to function as a computer, FAX machine, answering machine, and voice-mail system. I only know one person who actually used their computer as an answering machine. Most people told me it was too complicated to figure out how to use the combined capabilities; far easier to have a separate answering machine.

You Can’t Upgrade a Digital Convergence

After technology convergence, technologies promptly march on. The separate technologies keep evolving … separately. Cell phones get color, digital networks, downloadable ring-tones, and interactive games. PDAs develop more memory, plug-in cards, and direct connect capabilities with home computers. The owner of a PDA/phone combo can’t upgrade just the phone or just the PDA to get the new features they want. What was once ground-breaking becomes the biggest impediment to moving to better technology.

Technology Convergence Happens, Just Not Where We Thought

If convergence is really a myth, why doesn’t the myth die? Because convergence is real: markets may not converge, but technologies do. If you’re reading this article online, you’re almost certainly reading it on a machine that right now can do everything a home computer, fax machine, telephone, television, and stereo can do. The technology has been converging for quite some time.

Technological convergence can lead to great manufacturing efficiencies. I once consulted for a company that produced one high-end product. They released a low-end model by using a cheaper plastic casing and flipping an inside switch to disable some of the features. The manufacturing and inventory efficiency from having a single design was so great it didn’t make sense to have a separate low-end model!

Alas, pundits, vice-chairmen of the board, engineers, and business writers continue to mistake technological convergence for market convergence. They believe one leads to the other. But belief doesn’t make it so: the behind-the-scenes technological development has little direct effect on how the markets develop. Tech convergence may give us more choices, more markets, and more variety, but it will do it through market expansion, not market convergence.

Swiss army knives haven’t, don’t, and will never replace screwdrivers or knives. The technology has converged, but markets don’t care. Markets want variety: more price points, more colors, more features, and more upgrade options. Samsung may get great efficiencies from convergence, but at the end of the day, the only markets they’ll dominate with convergence are narrow niches in much larger markets.