The founders of TripAdvisor raised $4.2m of venture capital in mid-2000 and exited the business four years later for a $210m sale price. Their investors received roughly ten times their money. A great outcome for venture capital.
Today, TripAdvisor is a publicly traded company worth $10bn generating $200m in profits every year. TripAdvisor’s original investors could be receiving their ten times return every single year if they invested to own, instead of owning to exit. Returns flow to those who can wait. Most investors have time constraints or institutional imperatives that mean they can’t. In superannuation, members don’t need liquidity (to cash out) until they retire, thirty to fifty years from now for millennials.
History less well known than the past
The history behind this $10bn company receives limited media coverage. Stephen Kaufer cofounded TripAdvisor in 2000, along with Langley Steinert, Nick Shanny and Tom Palka. The plan was to build a massive database of travel content and white-label it as a search engine for web portals (think AOL and Yahoo). They hired editors to comb through archives of professional travel articles to add to their database and sell on a per-query basis. Their value proposition was to provide curated content that would be costly to replicate; a high-quality content farm if you will.
But over a year into their funding runway, TripAdvisor had closed only one licensing deal with Lycos, and they couldn’t even agree on who should pay who. Then, with limited funds left in the bank, 9/11 hit, decimating the travel industry. They considered closing down.
Kaufer felt that they had a business plan that was half right and half wrong. People seemed to want to come to a website to get third party opinions on travel destinations, but the business model of licensing that content to others was a failure.
Throw spaghetti at the wall
Fortunately, the company had built up a demo site on the side to show prospective clients what a vertical search engine could do – it was called TripAdvisor.com. When Kaufer saw TripAdvisor.com start to pick up traffic, he stopped what he was doing and looked more closely.
“Today, they call this a pivot, back then we called it scared sh*tless, throw spaghetti at the wall and see what sticks,” Kaufer now likes to say.
He decided to pursue an online advertising business model against the TripAdvisor.com traffic. They tried banner ads first, but those generated a disappointing 0.1% click through rate. Then they tried putting a ‘Check Rates and Availability’ button next to a hotel review; this had a remarkable ~10% click through rate. They had uncovered something valuable. Kaufer quickly signed up a hotel client who agreed to pay $0.50 a click similar to Google’s search advertising cost-per-click model.
On a whim, Kaufer also allowed users to post their travel reviews on TripAdvisor.com. When the company saw that these user reviews were getting all the traffic versus curated articles and travel information, they adjusted to focus on user generated content (UGC).
Three months into launching this new model, TripAdvisor was earning $70k per month and achieved breakeven. Incredible. The team had found a pocket of profitability on the interwebs, while every company around them in the dot-com bubble was imploding.
By 2004, TripAdvisor was generating $40m in revenue and $20m in profit. The founders and early investors made the decision to sell the business to IAC for $210m that same year.
At the time, Kaufer thought it was an excellent exit opportunity and believed it was a fair selling multiple. From a risk standpoint, the majority of their traffic came from search engines with uncertain motives. And IAC owned Expedia, which provided TripAdvisor with the bulk of its revenue. IAC could have played ‘hardball’ and turned off that revenue not dissimilar to the tactics used by Amazon when it acquired Quidsi in 2010.
“Now it’s the stupidest financial decision I’ve made in my life,” Kaufer says of the 2004 decision to sell the business. Kaufer now owns less than 0.3% of the $10bn company he founded. If he didn’t sell, his original stake would be worth more than a billion dollars.
He decided to stay at the company after the sale to IAC who allowed him to run it independently. A year later, in 2005, IAC spun out its travel-related assets (Expedia and TripAdvisor) as a public company. Then in 2011, Expedia spun out TripAdvisor as an independent public company. Each of TripAdvisor’s original venture investors, its founders, IAC and Expedia were sitting on a future $10bn company but still decided to offload their stakes. Long term ownership is a rare bird in financial markets.
The independent TripAdvisor company opened trading as a $3.5bn public company on December 21st, 2011. In five years, it would be worth $10bn. Why would you ever sell a high-quality, defensible business that is growing faster than the investment alternatives available in the market? True long-term investors can own a business until it has fully run its course and its returns return to the market average.
Spinning in intent
Why did TripAdvisor become a high quality defensible business worth owning over the long term?
In its early days, TripAdvisor was perfectly positioned to take advantage of a lack of content online (and in Google) pre-2008. Demand for content (search queries) far outpaced supply (good content). The reverse is now the case.
TripAdvisor spun up a highly defensible flywheel by building a community of contributors that created high-quality reviews. This content generated traffic from search engines, and more searches resulted in more users which meant more content produced. And that flywheel keeps spinning today.
The biggest mistake of investors is to invest in companies that don’t have the potential for defensibility. Profits attract competition who eat margins over the long term unless they are defensible. Time is the friend of the good business, and the enemy of the indefensible business. A flywheel is one form of defensibility against this.
Many of today’s most well-known informational sites such as Wikipedia, Yelp, IMDB and TripAdvisor rely on organic search traffic as their key marketing channel. It is now far harder to grow a startup primarily through SEO. Almost all monetizable search categories have vast excesses of search engine optimised content. Moreover, the playing field is uneven. Google is itself creating content which, at least at times, they have favoured in their search results.
Many successful startups employ underutilised marketing channels to reach scale and win the market share of mind. Usually, those channels are promising because they are new and novel. In 2009, it felt personal to receive a brand message in your Facebook newsfeed. Now, it’s annoying and feels contrived. It is now far harder to grow a startup primarily through social. Over time, all marketing channels become saturated and decay in value. As more companies discover an effective channel, it becomes crowded, expensive and ignored by consumers.
Ultimately, the endgame is not efficient marketing channels; it’s referrals and share of mind. Every time someone tells you to ‘Google it’, you’re being referred. Google has the share of mind in web search. They don’t need to buy billboards to get you to enter their funnel anymore.
Advertising businesses become valuable as they can build (and purchase) traffic on one side for less than what they can onsell that traffic to advertisers as a newly created marketing channel. Ideally, if the advertising business is winning the market share of mind, the margin between acquisition and revenue should increase over time. For every dollar that TripAdvisor spends on marketing, it generates over two dollars of advertising revenue. This axiom is the core to understanding TripAdvisor; the hope for shareholders is for this spread to expand substantially over the next decade, as the size and speed of their flywheel continues to grow.
Engagement lowers initial customer acquisition costs
One way to reduce acquisition costs is to build a product that is significantly better than the existing experience. The bigger the delta, the more people will engage with it and talk about it to others (referrals). Before TripAdvisor (and even now), it was hard to get reliable, helpful travel information. Lowering acquisition costs expands margin.
Another way to expand margin is to overreach on the economic take from advertisers in the short term. In the past, TripAdvisor has been criticised for using sleazy SEO tactics and then burying its travel content under a slew of obnoxious click-through ads. This behaviour increases ad revenue in the short term at the detriment of the product experience, reducing engagement, making it harder to get referrals, which means more marketing costs to drive users back to the site in the future.
Kaufer understands this interplay, and his product roadmap continues to focus on two things: building engagement around the research process (helpful content) and closing the loop on attribution (getting the economics right as a marketing channel).
Intent generation versus intent harvesting
The online ad attribution system currently punishes intent generators and rewards intent harvesters, particularly last click intent harvesting. Content sites generate intent to purchase versus a booking engine that harvests it. People use travel reviews at the beginning of the travel research process, which on average takes weeks. However all CPA (cost-per-action) and CPC (cost-per-click) ad programs pay only for the last click, which usually means when people are purchasing tickets or making reservations. Content sites, like TripAdvisor, are getting an unfairly low share of advertising revenues. For the most part, you don’t get paid for providing the research since it’s too high in the funnel.
As with all large problems, this misallocation of advertising dollars also presents opportunities. One opportunity is for TripAdvisor to close the loop themselves with their instant booking feature that they have begun rolling out. TripConnect Instant Booking, currently in beta in the US, is a way for all suppliers to load inventory into TripAdvisor’s hotel metasearch. In the instant booking model, partners pay TripAdvisor a percentage of the booking value for completed transactions. The CPA model is quite similar to what OTAs (Online Travel Agents) charge hotels: a fee per transaction, paid after a guest’s stay. Expedia and Priceline, who are estimated to spend 12% of their total advertising budgets on TripAdvisor, do not want to participate in this (as you can imagine). Expedia CEO Dara Khosrowshahi said in a recent quarterly conference call:
“We are anticipating some headwinds on the top line because of that as TripAdvisor rolls out Instant Book more expansively, we will have less access to TripAdvisor clicks, so to speak, but we certainly think that’s manageable.”
By participating in instant booking, they are displacing reservations that would have come in via an OTA otherwise, therefore helping improve competition on commissions and increase their leverage against the intermediaries. It’ll be interesting to see how many years of those it’ll take before TripAdvisor’s shift from being a reviews site to being an OTA-lite site is widely grasped.
If over time advertising dollars did shift to being correctly allocated across the research-to-purchase funnel, this would also reward TripAdvisor. It makes sense that the most valuable part of that funnel should be the research step. Both trends are positive for TripAdvisor over the next decade. TripAdvisor will benefit from any innovation on attribution, which is hugely incentivised to occur, or by closing the leak on intent harvesting.
TripAdvisor is exactly the sort of company we seek at Spaceship. A company with a strong economic engine and a sound level of defensibility, that benefits the long term investor the most. And typical of founder-led companies, Kaufer is not stopping. “Speed wins,” the sign on Kaufer’s office door reads. Even now, the $10bn company still strives to retain a start-up’s sense of urgency with weekly code releases and a culture of modesty that speaks much to its founding.