The Catalyst Code by Dave Evans and Richard Schmalensee is dominating the water cooler talk at Meritage. It’s rare that a business strategy book really hits the mark, but The Catalyst Code does as it was written for the 21st century VC and entrepreneur.

With unprecedented levels of broadband connectivity and the widespread adoption of the Internet, businesses today are able to bring together different sets of customers to allow them to interact in ways never before possible. This is what the authors call a multi-sided business platform. Getting customers to interact on such a platform is a catalytic reaction. Rather than creating new products or services, catalyst companies figure out how to allow participants in an ecosystem to interact more efficiently (or in some cases to interact for the first time), creating enormous value within the ecosystem. Meritage has invested in five catalyst companies to date and is a huge believer in the premise that multi-sided businesses have the ability to transform industries. A perfect example is our portfolio company Pipeline Financial Group. Pipeline is an electronic securities trading platform that allows institutions to trade large blocks of shares directly with one another: no more need for a broker. By doing so, institutions avoid the $20 billion annual cost resulting from brokers “front running” their orders.

Catalyst companies offer tremendous opportunities as they’re often rooted in huge industries; however, they also have special challenges. First and foremost, the company must attract the various participants into the ecosystem at the same time – you can’t conduct one sided transactions in a catalyst company! Pricing also becomes very tricky: do you charge all customers using the platform or do you consider subsidizing or even (gasp) paying a key customer group for its participation? The idea of subsidizing a customer always gives VCs the chills: Pets.com and Vonage spring immediately to mind. But these infamous companies were single sided businesses subsidizing their only customer with no second-side of their market. In a catalyst company, there are at least two and sometimes more distinct customer groups, and it may be necessary to incent the customer group that can start the catalytic reaction. Our mobile search company Mobile Content Networks is doing just that. MCN has numerous distribution agreements with leading wireless carriers and hardware manufacturers including Sprint, DoCoMo, Nokia, Yahoo! Japan, Tele2 and SMART. MCN does not charge these distribution partners to implement its search technology. These partners are the key to reaching the consumer, and MCN now reaches over 365 million mobile subscribers. This reach is a huge asset and one that MCN is monetizing through advertisers. Had MCN charged either the carrier or consumer for search, it likely would have failed. Instead, MCN charges the participant in the ecosystem who is the most motivated to reach the consumer: the advertiser.

As Bill Gates comments in the book, this is “how breakthrough businesses can be built in today’s economy”. We agree. Catalytic investing is one of the most promising investment areas and we continue to aggressively pursue these ideas. If you haven’t read The Catalyst Code – do it and join the 21st century!

Tags: Catalyst Code, MCN, Pipeline Financial Group, platform