Altos Ventures Musings

They Can't Tell You How To Soar

Customers will always tell you they want better products and lower prices. They might even be able to articulate how much better certain products should be. But don’t expect them to be able to tell you how different those products could be. More importantly, don’t expect them to tell you how you should surprise and delight them.

This was an insight from a book called Different, Escaping the Competitive Herd written by Youngme Moon (I won't review the book but I'd recommend it for entrepreneurs and marketers fascinated by inconic brands such as Apple, Harley Davidson, IKEA and InNOut Burger). 

As Clayton Christensen explained in the Innovator's Dilemma, there is a predictable pattern in just about every product category. Innovation leads to products that improve to a point where customers are over-served (the web browser might be the latest category to reach this level).

From a vendor's perspective, the problem is that over-served customers become so skeptical about the differences between products and brands that differentiation is rendered meaningless. Most customers become not only bored but unhappy.

In category after category, over-served, bored and unhappy customers would love to discover something delightful, remarkable and refreshing. And marketers spend billions of dollars trying to rise above the competitive noise.

Ironically, intense competition only quickens the pace toward blandness and a herd mentality in markets. This trap is hard to escape. The herd phenomena is seen in self-organizing systems as disparate as ant colonies, bird flocks and stock markets. 

Paradoxically, the best way to stand out, might be to NOT focus on beating the competition. At the 1997 WWDC, before he rejoined Apple as CEO, Steve Jobs stated the following (32:43 of video):

"...the other thing I feel very, very, very strongly about is, it's incredibly stupid for Apple to get in a position where for Apple to win Microsoft has to lose. That's really dumb... Apple can win without having to have Microsoft lose."

Don't focus on being better. Don't fret over differentiation. Think Different. Be different. Transcend boundaries. Stand alone. Walk down a very lonely path. 

Something that every entrepreneur should keep in mind is what Jerry Garcia once said: 

"You do not merely want to be considered just the best of the best. You want to be considered the only ones who do what you do." 

What will you do? How will you be different? One place to start, is to be yourself. Be genuine.

To really, really soar, don't just be better, faster, cheaper. You can do better than that. And please, please, please, don't aspire to be "the Mint of XXX category" or "the AirBnB or YYY category" or the "Groupon of XYZ category."

Overused and Misunderstood - Capital Efficiency

"Capital efficiency" is such an over used term these days I don't even know what it means anymore.

Some startups think that burning $100k per month is too high while others think $100k/mo is close enough to zero that it's "near break-even."

Vinod Khosla has proclaimed that a company which burns less than $100 million is "capital light" (he was referring to clean tech). At $100k/mo, it would take almost 3 generations to burn that much money (each generation is about 30 years).

The problem is that the monthly burn rate or total funding doesn't say much about efficiency. The return on capital is the key metric needed to determine capital efficiency and most startups have no clue because they don't even know if they have a business (yet). 

Another problem is that startups are not efficient. In fact, they are so inefficient that their trajectories are often referred to as "drunken walks." 

Big companies are built for executional efficiency. Startups are built for innovation. It requires a certain mindset. A willingness to experiment, endure mistakes, allow for some slop and forgo efficiency. 

Steve Blank likes to describe startups as organizations formed "to search for a repeatable and scalable business model" (others might add a step - find product/market fit, then look for a business model).

While I like Steve's definition, it's important to emphasize that the goal of a startup is NOT to stay in a limbo state of experimenting, learning, pivoting, and searching for product market fit or business model.

The goal is to find something that works and scale it.

For some entrepreneurs, this is when the fun ends. For others, this is when the fun begins. It's funny how some entrepreneurs feel like they are just getting going long after they've built billion dollar companies (examples include the founders of companies such as HP, Intel, Microsoft, Apple, Oracle, Amazon, Google, Facebook).

As a startup grows, more and more parts of the company will make the shift from exploration/learning to execution mode. At first, it might be just the founders and engineers, then the sales team, then the marketing team and eventually the entire company. 

So, rather than capital efficiency, perhaps we should think about constraining the capital in startups...until they are ready to scale? For example, at Y-Combinator, founders are initially paid roughly the equivalent of a grad student stipend - barely enough to pay for meals and a shared apartment.

At the right right time, there is no question that a startup should raise the capital needed to take advantage of the opportunity at hand. In fact, I'd recommend raising a bit extra, to allow for ample cushion and a margin for error.

But until then, "capital constraint" or "capital restraint" might be better terms to think about than capital efficiency. 

 

Another Perspective on Yahoo!

Paul Graham published an essay about "the problems that hosed Yahoo" which got shared by many people via Twitter and Hacker News. Many people called it "customarily brilliant." 

I really enjoy Paul's writings but this one didn't sit well with me. I disagreed with key points and came away concerned that young entrepreneurs would learn the wrong lessons from history.

In the essay, Paul suggests that Yahoo failed due to two problems - 1) easy money and 2) ambivalence about being a technology company.

Money

Paul takes us back to 1998, when Yahoo was riding high, making money from big brand advertisers as well as over-funded, "fat startups" (a term popularized recently by Ben Horowitz). In Paul's words, Yahoo was "a de facto beneficiary of a pyramid scheme."

I agree that too much easy money, especially over-funding, can harm companies. Too much money can mask problems. That said, I don't think it had much to do with Yahoo's demise.

We can second guess how Yahoo could have re-invested profits but I would not fault them for pursuing it. They built a very successful company which beat every competitor of their era. 

Everyone benefited from the bubble. If Yahoo had not taken the money it may have been diverted to others and weakened its competitive position. You have to be in the game to even have a chance at riding the next wave. 

Maybe what Paul meant to say was that Yahoo management should have recognized that they were lucky or that their business model was not sustainable?

In hindsight, it's clear that Yahoo did not appreciate the potential for search and perhaps over-estimated the quality of their revenues. But, as Paul acknowledged, no one else, including Larry and Sergei, knew how big search was going to be, in 1998.

It's hard to predict the future and deceptively easy to come up with simplistic explanations in hindsight. Yahoo beat its competitors hands down and built a very profitable, growing business. I would not diss them for it.

Paul's second point was about culture and leadership.

Hackers 

Paul suggests that Yahoo was a technology company but either didn't know it or were ambivalent about it. He also seems to imply that if hackers had run the place Yahoo would have been fine (or at least would not have been hosed).

I disagree with both points.

Yahoo was never a technology company. They were a media company (albeit a "new media" company) from the day that Dave and Jerry started serving up pages from their trailer at Stanford.

When Mike Moritz invested in Yahoo, it was the emerging brand and traffic that impressed, not the technology. Unlike Google, there was no core technology from day one. Later on, Yahoo did develop many technologies - they had to in order to scale (Hadoop is one example).

Bill Gates would have also said that Yahoo was never a technology company. When Gates saw Google, he saw a company that reminded him of Microsoft. It was probably the only company that ever scared him. He never had that reaction to Yahoo.

The important thing is not to be like a Google or Facebook (or the early Microsoft). The important thing is to be yourself. Be authentic. Be genuine.

So maybe Paul's point is that Yahoo didn't know who they were. Perhaps, but I disagree that Yahoo had to be like a Google or Facebook because that is not who they were.

Pixar is a great media company. The fact that they were founded by technologists doesn't confuse them. They even sell rendering software to other companies, including competitors. It doesn't diminish their identity as a media company. 

Disney is another example. Walt Disney Imagineering has been inventing cool new technologies for decades. They were the "new media" company of their generation. You don't have to fit someone else's mold. Be yourself. Be unique.

Another key point Paul seems to make is that "adult supervision" is bad. Implication seems to be that if hackers had run the place Yahoo may not have lost. Again, I disagree. 

There is good adult supervision and bad adult supervision.

Amazon is an interesting case study that, on the surface, defies hacker conventional wisdom. Even as they delve deeper into technology, Amazon's management is stacked with MBAs.

Even their most technical businesses, Amazon Web Services and Digital Media (including Kindle), are led by a Harvard MBA and a Stanford MBA, respectively. Even so, Amazon continues to attract and retain plenty of good hackers. In fact, momentum seems to be increasing in the hacker community. 

There is nothing inherently wrong with adult supervision or non-technical management per se.

That said, I do think people can get seduced by the belief that there is a mythical "world class" management team that can fix your company. On this front, I think Paul and I probably agree. Don't count on someone coming in from the outside to fix your company (or, in the case of Yahoo, your stock price). 

When the bubble crashed, Yahoo looked for a savior. In contrast, Amazon stuck with Jeff Bezos even though their stock took a similarly huge beating. Bezos likes to remind everyone how the pundits called them "Amazon dot toast."

Terry Semel knew little about Yahoo or the Internet when he took over in April, 2001. It quickly led to the mass exodus of the future leaders of Yahoo. The fallout we are witnessing now may still be the after shocks. 

To conclude, I'd like to share a great story about how Nike is still shaking up the shoe industry. When Phil Knight retired after almost 40 years as CEO, he decided to bring in fresh blood and passed over the leading internal candidate for CEO. 

Luckily, Nike had such a strong culture that it quickly rejected the outsider. The new CEO, from S.C. Johnson (the makers of Pledge, Windex and other cleaning products) lasted only 18 months. The new CEO is a home grown prodigy - a former shoe designer who was the internal CEO candidate in 2003. 

With 33,000 employees, there is plenty of "adult supervision." It just happens to be the right kind. 

So What's With All This Talk of Failure?

Have you noticed all the talk and blog posts about failing? Here are some examples: 

• Peter Rip: Fail Fast, Fail Often
• Josh Kopelman: Failing Cheaper
• Brad Feld: The Best Entrepreneurs Know How to Fail Fast 
• Scott Wolfgang: Even VCs Should Learn to Fail Fast 
• Auren Hoffman: To Grow a Company You Need to be Good At Killing Things 
• Anthony Lee: Failing Fast 

The main message is this: it's not only OK to fail, but it might be the smart thing to do if you do it quickly and cheaply and learn from the experience. 

In a book called The Dip Seth Godin takes it a step further and advocates the idea of quitting or killing off something early before you even have a chance to fail. To be fair, he also says that - many times - the right thing to do is to keep pushing ahead (because you are just hitting "the dip" before you reach eventual success). But that's just conventional wisdom right? It would not sell many books or drive page-views.  

Mark Suster in his recent post called Why the 'Fail Fast' Mantra Needs to Fail calls bullshit on all this talk of failure. So does Jason Fried who wrote the following in Rework: 

“In the business world, failure has become an expected rite of passage. You hear all the time how nine out of ten new businesses fail. You hear that your business’s chances are slim to none. You hear that failure builds character. People advise, ‘Fail early and fail often.’

“With so much failure in the air, you can’t help but breathe it in. Don’t inhale. Don’t get fooled by the stats. Other people’s failures are just that: other people’s failures."

What people are talking about when they espouse "failing fast" is fairly basic. Before you become great at something you might stumble along for a while. If something's not working, try something new or different. As Einstein said, the definition of insanity is doing the same thing over and over again expecting different results. 

My 3 year old son seems to have no problem grasping this concept. He doesn't have fancy terms like experimentation, iteration or pivoting to describe what he's doing; and he certainly doesn't think he's failing. He's absorbing, learning, trying new things and having fun.  

To become good at anything, you need to give it a shot, experiment, practice, learn, iterate. No big deal. Let's NOT call it failure. Let's call it what it is. Mark's suggestion was "launch and learn" or something else. I hope people take his advice.

Having said all that, I'd like to provide an example of the best fail fast (or quit early) story I've heard in a while and explain why it does make sense to cut your losses sometimes. I also want to explain why I believe the "fail fast" meme took off in the venture community. 

The story was told to me over lunch last week by Glenn McGonnigle who recently started TechOperators, with other proven entrepreneurs and executives in Atlanta. I think they are one of the best VCs in the world in the security market (they are co-investors in a recent deal). 

In the mid 1990s, Glenn started an online backup company. I think you'd all agree that he was a bit early! After some struggles, one of his angel investors Kevin O'Connor approached him to have a little talk. Kevin hinted that the market might not be ready for what he's doing so perhaps he should consider joining a couple of other companies that he was working on. It was totally up to him to decide what to do (but read between the leaves, there will be no more funding).

After thinking it over, Glenn came to the conclusion that he was too early and decided to shut down his company and take up Kevin's offer to check out his other ventures. The first company was targeting the Internet advertising market, which was still in its infancy in 1995. The other company was also in a nascent market for network security and penetration testing software. Glenn decided that he didn't know anything about the ad business and joined the latter as VP Sales. The company had just $50k in angel funding from Kevin and had hired Tom Noonen as CEO (Tom is a co-founder of TechOperators with Glenn). 

In their first year of operations the company did $300k in revenues. The next year they sought their first round of funding. Glenn didn't know any VCs except for one guy he used to work for - Bob Davoli - who had recently joined Sigma partners. The other VC was Dave Strohm of Greylock, who happened to be the only VC that Tom knew. So, in 1996, a little company named Internet Security Systems (ISS) based in Atlanta raised $3.5M from Boston and Bay Area VCs. 

The following year they raised Series B from Kleiner Perkins Caufield and Byers (Ted Schlein, who was formerly with Symantec and knowledgeable about the security space, led the round). The year after that (1998) they completed an IPO and the stock shot up 70% the first day. The year after that ISS completed a BILLION dollar secondary offering. At its peak, ISS reached a market cap of $4B. Even after the Dotcom crash they continued to grow to $400mm in revenues and were eventually acquired by IBM for $1.4B in 2006.

It was an amazing return for everyone especially Kevin O'Connor who bought an initial 30% stake in the company for $50k. Given that Kevin recruited both the CEO and VP Sales that took the company public, I'd say that he deserved it (the technical founder, Chris Klaus, was a student out of Georgia Tech). 

BTW, the company that Glenn passed on is the company that Kevin O'Connor is better known for - DoubleClick, which also completed its IPO in 1998. They initially had a different name and were based in Atlanta before moving to NY where most of their customers were based. 

So, as it turned out, Glenn could have chosen either company and would have done great. The only wrong choice would have been to stick with his original company! 

The lesson in all this? Sometimes it is better to move on. However, as Mark Suster points out, when you take money from investors you have a moral responsibility. To just walk away and abandon customers, investors and other stakeholders would be "irresponsible, unethical and heartless" using Mark's eloquent words.  

Although I agree with Mark, I would like to point out something which helps explain why the fail fast meme took off in the VC world. In my experience, entrepreneurs are usually the last people to quit. VCs typically give up on companies long before entrepreneurs do! 

One example from my personal experience is the founder of Enwisen, one of our portfolio companies from 1996. Everyone gave up on the company except for the founder and his wife who were both in their 60s. They just refused to give up even with no more funding and no employees left in the building. 

The founder has since retired but the company lives on. All debts have been paid off and all VC and angel investors have a chance to not only get their money back but make a profit. The company has been profitable for years and grew 60% last year, even during one of the worst recessions in decades. The CEO gets calls all the time about potential M&A or growth equity rounds. Maybe one day they could even go public, like Financial Engines did today in the hottest IPO of 2010 (they were also founded in 1996). 

When you are working with true entrepreneurs, you don't have to encourage them to keep going. More often than not, you have to provide a different perspective, point out the realities and, as Kevin O'Connor did, provide some alternatives that might mean moving on.

It really should be up to entrepreneurs to decide whether to quit or to keep going. As a VC, if I picked the right person to back, I don't have to worry about him/her quitting on me. But, sometimes, I do have to have a little talk to point out realities that the ever optimistic and passionate entrepreneur might not see.