@altgate

Why 37signals?

Simple, they make killer products, they are a cash machine, it’s an attractive business model and they’re visionaries.

I’m a huge fan of Basecamp.  For the few people who haven’t heard of Basecamp, it’s a team collaboration and project management tool.  Adoption amongst startups is high, but it has crossed the chasm and large companies are now adopting it with gusto.  I was in a meeting a couple weeks ago with some senior guys from a large (read billion dollar) offshoring/BPO company where they were pitching me for some business.  They spent 10 minutes of an hour-long meeting raving about Basecamp and how it made them “feel” like a small company.  They knew their competition for the deal was a group of smaller companies and part of their argument as to “why them” was Basecamp!  You know you have a killer product when people start ascribing emotions to it.

37signals has several other products, but Basecamp accounts for about 60% of their projected $8 million in 2008 revenue.  By the way, my friend Jed Christensen has a killer blog post on 37signal’s financials where he walks you through how he reverse engineered their numbers.  If Jed’s numbers are right, 37signals is a cash machine (with only 12 employees and annual costs of $2 million before taxes and $6 million of EBITDA).  A company that produces those kinds of numbers is certainly going to attract M&A attention even in a depressed market.

37signals also has a great business model.  They’re considered the “gold standard” for the freemium model where you give away basic service and charge for enhanced features.  Their free trial and $24 per month basic service level make it very enticing to try out.  This is exactly what’s killing Microsoft Project specifically and Microsoft’s application business generally.  The low price also keeps them from getting the axe when budget cuts come.

Finally, the good folks at 37signals are true visionaries and not just on the technology or business front but in terms of building great organizations too.  I haven’t met founder Jason Fried but reading interviews and stories about him, he’s clearly the real deal.  And they didn’t just create a great company they also spun off their technology into an open source framework (Ruby on Rails) and refined a new form of development termed “Getting Real.”  Think about that for a minute.  Here’s a company that is doing amazing things and they also had the time to create the dominant web 2.0 development framework and write a book.  Yes, they’re a small team, but that too is a testament to their talent.

Why Microsoft?

Simple.  They need it.  Microsoft’s application business is about to start a long, steady decline.  It reminds me of the newspaper business; it’s just been made obsolete.  The concept of buying a piece of software, installing it on my desktop and then using it sporadically for the next several years without improvement is as over as reading news on a dead tree.  The writing is on the wall and it seems that Microsoft just hasn’t gotten the memo.

Remember Visio, the $559.95 software you use to draw complicated flow charts?  I always hated it that it cost so much and I only needed it a couple times per year.  Well, recently I’ve been playing around with the beta of Flowchart.com.  Check out this screen shot.  It’s a killer webapp sure to severely eat away Visio’s marketshare.

Note that to resize and crop this picture I didn’t use $699 Adobe Photoshop, instead I used SnipShot which is free.  Google and an army of other startups are methodically eating away at Microsoft’s core applications business and there is just no stopping that.  The folks at Microsoft are smart and I’m sure they are looking at this but what a huge problem they face…cannibalizing your own business.  It has to be done and the only question is how and when.

In terms of how, it’s clear that Microsoft’s 90,000 employees aren’t going to be the source.  If they were, it would have happened already.  So that only leaves the “buy” option and since Microsoft can’t buy Google, 37signals is the next best choice.  In terms of when, 2009 is the right year because it will be at or near the bottom of this economic cycle.  The price will never be cheaper.  And Microsoft is still sitting on a cash hoard.

So why $300 million?

Because that’s what it is going to take.  On the financials alone, 37signals should be worth about $80 million (10X revenue).  Not chickenfeed, but still not enough to get remaining founder Jason Fried to sell.  Jason is “famous” for saying he’d never hire someone who didn’t use a Mac.  So basically getting Jason and his team on board is going to take throwing a lot of cash at the problem on the part of Microsoft.

But that still won’t be enough.  Microsoft will also have to commit to porting Ruby to .NET and supporting RoR and Get Real throughout the firm.  Fried and his team will be given special evangelist roles and retaining them post transaction will be a key success factor.  I suspect Bill Gates will have to personally get involved in convincing Fried and company to go along.  A couple of years ago 37signals took an investment from Jeff Bezos, and not for the money or connections but for a relationship and advice so it shows that non-monetary motivation is at least as important as the money itself.

Of course this all probably won’t happen, but it was fun to write.

Happy New Year!