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How a VC picks winners

– What makes a great business idea? And what makes a great business idea scalable, sustainable, and worth the investment? That, among other things, is what Christian Miele, partner at e.ventures, asked Fabian Heilemann, cofounder with his brother Ferry of DailyDeal, Europe’s first couponing portal for offline SMBs, in this Digital McKinsey interview.

In 2011 the brothers Heilemann sold DailyDeal to Google for over $100 million. Since then, they have invested in over 30 businesses through the VC company Earlybird, largely focusing on SaaS models and platforms.

Miele: Fabian, when do you say, “Hey, this is a really great idea; this has a lot of potential”?

Heilemann: For me, what defines a good idea, and what I’m looking for as an investor, is a profitable business over time.

Miele: Is there a secret sauce that can make an idea successful?

Heilemann: If you can make your hobby or your passion your business, that’s the sweet spot. However, not many passions make a great business. My brother and I failed following our passions a couple of times. Then we said, let’s set passion aside and look for a business model with a proof of concept in some other market that we can bring to Europe with a high likelihood of it being adopted.

We did the analysis top-down. We developed a scorecard and looked at market sizes and value chains. And out of a long list of models, DailyDeal was top of the list. It was doing what Google did for online to online, generating leads for online shops. Nobody was doing that for offline SMBs. They were advertising in the Yellow Pages and radio. So DailyDeal was driven by a very analytical and structured approach.

Miele: What would you tell a university student who wants to start a business?

Heilemann: Each product that a start-up builds should be about solving a problem. If it doesn’t solve a problem, there’s no market, there’s no willingness to pay, there’s no business. It’s a philanthropy, or a hobby, or whatever, but it’s not a business.

Miele: Let’s talk a little bit about unit economics. My feeling is that it’s getting ever more important today to figure out the lifetime value of a user of your services. Why should we pay so much attention to it?

Heilemann: This is a broad field—unit economics or KPIs in general—and KPI benchmarks are very specific to a business model. In e-commerce it’s completely different than in a two-sided marketplace where you need to scale supply and demand at the same time, or in a SaaS model, where you look more for recurring revenue.

In the United States, many investors have a cowboy attitude. They’re willing, over many stages and with hundreds of millions of dollars, to keep financing businesses that are generating massive losses because they believe in first conquering the market and putting everybody else out of business. Once you own the market, then you can start making money.

This is how a lot of Silicon Valley companies have gained global dominance in their space, because they find people on the West Coast who are up for this game and who are completely fearless. Europe is different, especially Germany.

Miele: Do you think that could be because of the difference in the competitive environment in Europe? Because there are not so many VC funds, so it’s not as competitive, and you can take more time to evaluate a company instead of adopting the cowboy approach?

Heilemann: That may be one reason, but the German DNA is less prone to taking huge risks. It’s the engineering way: incremental optimization. I think that makes it harder for us to build global champions. We must learn from people like PayPal founder Peter Theil and make bolder bets. In many markets, that simply works.

And you need to look at entrepreneurial potential on a sector-by-sector level. In travel, for example, it’s over. Ninety-nine percent of the market has been addressed with state-of-the-art technology and shows superhigh customer satisfaction. In e-commerce, it’s the same thing. There’s no point starting businesses in those two sectors with the ambition of building something really big.

They were first tackled by digital entrepreneurs in the 1990s. Now you have a few leading players, and they’re the sectors most advanced in digitization. But there are 25 other big industries that are somewhere in between in digital transformation. Until all industries are completely digitally transformed in the way that retail and travel are today, there will be problems to solve. I think that will easily take 20 or maybe even 30 years.

For the last ten years, we’ve been working on the transition from desktop to cloud. Then the transition to mobile. Now we’re working on replacing repetitive manual tasks with AI and robotic process automation. We can talk about VR and AR, about mobility and transportation, which is an area I’m very excited about, and all the IoT and software-hardware combinations.

So, look at those megatrends and try to get an idea about where each sector is on the curve. Then match that with what you’re intrinsically interested in, what you’re passionate about, where you have an opportunity, and off you go.

And then it’s also a little bit a matter of luck.