Startups, Ethics & Regulation

By Rick Thompson, Wharton MBA 1996; Partner, Signia Venture Partners

A few years ago I sold some Montana lakefront land to an entrepreneur by the name of Steven Sann with the grand vision of building a youth camp to foster “self-reliance, cooperation, and problem solving in America’s future leaders.”  ‘Great to see an entrepreneur giving back,’ I thought to myself.  I was stunned when I recently learned that this supposed altruist was now charged by the Federal Trade Commission for running a $70M phone scam – charging customers for services they did not order. While I never met the man, I was intrigued by how an apparent do-gooder could be such a dirtbag, so I dug deeper. Turns out Steven Sann worked with third party marketers known as offerwalls, who in turn worked with destination websites, to deliver package ‘offers’ to consumers.  Ouch.  Much to my horror, I realized my real estate transaction may not have been my first dealing with Mr. Sann.

Most consumer applications attempt to deliver users a low friction experience in getting them into the top of the sales and conversion funnel.  In the ‘free-to-play’ model of social and mobile gaming, for example, users are then monetized through the selling of virtual goods or services.  Users can pay real money for these goods or obtain them by completing what are known as offers in the industry.  An offer could be something benign such as signing up for Netflix, in which case an affiliate fee is earned, or it could be something more insidious such as providing your phone number in exchange for a ‘free ring tone.’  Somewhere buried in the contract for a free ringtone may be something like an agreement to accept a voice mail service along with an auto-renewing phone bill.  Steve Sann had hundreds of thousands of paying customers with only about a dozen actually using his voice mail service.

I first became aware of the offerwall industry in early 1998 when Playdom, a Signia portfolio company in the games space, signed on with OfferPal to handle both credit card processing and offers for its free-to-play games.  Playdom and other data driven companies viewed the offerwalls as a commodity to be optimized for maximum revenue.  The result was a race to the bottom, with offerwall providers resorting to increasingly dubious schemes aimed towards monetizing users and maximizing revenue.  By the end of 2009, offers were delivering about 30% of total revenue to games on Facebook and Offerpal, the most aggressive of the three major offerwalls, dominated the business.

This scammy offer practice only came to a halt after a major public outing from Michael Arrington of Techcrunch (Scamville: The Social Gaming Ecosystem of Hell).  The most serious offender, Offerpal, was booted off the Facebook platform, and Trial Pay, the most legitimate of the offerwalls according to Arrington, was granted de facto monopoly status.  

In this case, the need for regulation was averted, justice prevailed and the company taking the high road was rewarded.  However, I cannot help but wonder how much damage was done in the interim, not just to the users whose trust was betrayed, but to the ultimate potential of the industry.

Entrepreneurs pioneering new business models and platforms can suddenly find themselves facing ethical dilemmas they are unprepared to handle.  Do you pursue each and every underhanded tactic in the book to maximize revenues? Or do you sacrifice your business to those that do?  In established lines of business, where innovation is slow, the rules of conduct are pretty well established.   However, in emerging business and in areas of innovation, I suspect this dilemma is played out all too often and the good guys do not always win.  In the case of TrialPay, the company emerged victorious only because their competition was eliminated and they received a de-facto monopoly.  If instead Facebook had decided to act as a regulator, introducing and enforcing rules of conduct, it is likely that OfferPal would have continued to dominate since its lead was just too great.  In that event, TrialPay may not have even survived. In retrospect Facebook made the right decision.  By establishing a monopoly, Facebook removed competitive pressure that would have inevitably pushed the boundaries of ethical behavior.  Granting monopoly status, not to the leader, but to the company that had exhibited the most restraint, was also the right thing to do.  Even though Facebook wasn’t necessarily proactive, it deserves kudos for having created the right structure and incentives.

Emerging industries are best served when its leaders articulate a vision for the industry.  When building out an ecosystem, the platform’s values help guide the development and behavior of the ecosystem.  Facebook has yet to communicate vision or values and the ethos of its current ecosystem reflects that.

In the past year, the social casino category has been one of the few growth areas on Facebook, attracting entrants from the casino industry as well as traditional free-to-play Facebook developers.  This will be an interesting test for the platform as two very different worlds collide.  The land-based casino industry has long lived under very strict regulations designed to protect the consumer.  The free-to-play gaming industry on Facebook, on the other hand, has no such rules.  It is widely suspected that certain social casino games made by developers from outside the land-based casino industry do not use random number generators to generate ‘luck.’  Rather, they find that they make more money with scripted outcomes designed to maximize addiction and revenue.

It is a welcome development that leading representatives from both the gaming and land-based casino worlds – including Caesar’s and Zynga – find common ground in joining together to fend off regulatory efforts and ‘self-regulate.’  As a first step in this process, Jeff Hyman, CEO of Idle Games (creator of Fresh Deck Poker, a company in which I invested) has called for self-disclosure, transparency, and making the data stream available for external verification.    It is in everyone’s interest to avoid another Scamville as well as governmental regulation.   This credible move by the industry toward self-regulation is a welcome initiative.

For further reference please see the following articles:

Steven Sann case: http://www.huffingtonpost.com/2013/01/21/bogus-phone-bill-charges_n_2521334.html

Jeff Hyman’s opinion:  http://www.socialcasinointelligence.com/tag/jeff-hyman/

 

ThompsonBio: Rick Thompson is a Wharton MBA ‘96 and partner at Signia Venture Partners. Signia is an early stage fund dedicated to helping passionate entrepreneurs realize their vision and build impactful, high-growth ventures.

Follow Rick on Twitter: @rl_thompson & @SigniaVC