Altos Ventures Musings

Start From the Heart

 
Every year at Altos we see thousands of investment proposals and meet hundreds of entrepreneurs.  We basically boil them down to two types: companies that start from the head and companies that start from the heart. 

“Start-from-the-head” companies are started by business types, often MBAs, who are motivated primarily by their interest in starting and running a company of some sort.  These companies often come in with slick presentations, fancy financial models and detailed business plans.  They talk about things like addressable market, segmentation, channels.  “Start-from-the-heart” companies are usually started by engineers and tinkerers who have a burning personal passion for solving a problem that they have struggled with – sometimes for years.  What they lack in formal plans they make up for in working products, paying customers and real passion.

We have a strong preference for the latter type of company.

That is not to say that MBAs don’t build great companies, but it comes down to a question of motivation.  We have found over time that the most enduring and successful companies are the ones created out of a founder’s deep personal conviction around solving a very specific problem.  And they’re usually the most fun to work with.

Sometimes these ideas arise from a personal passion.  David Baszucki is the founder of an online building world called Roblox.  After successfully selling his first startup, Dave chose to build a company that was near and dear to his own passion as a tinkerer (I’ve personally experienced his homemade ziplines and potato cannons).  Dave also wanted to build something cool and constructive for his four creative kids.  Roblox is now one of the most trafficked kids websites in the entire country.

Jeremiah Grossman was just a teenage computer enthusiast when he hacked Yahoo! and caught the attention of David Filo, who hired him within weeks.  Jer eventually left to start Whitehat Security, the world’s foremost web application monitoring company.  He’s one of many fortunate founders who’ve turned their hobbies into great companies. 

Many huge companies have been started as personal projects or academic inquiries.  Sun Microsystems was born after graduate student Andy Bechtolsheim cobbled together the Sun-1 as his personal CAD workstation.  Larry Page was fascinated by the mathematical structure of Web links when he wrote his Stanford dissertation and created BackRub, which later became Google.  Mark Zuckerberg’s predecessor to Facebook was Facemash, a Hot-or-Not site he hacked while drunk in his dorm one night.  I’m pretty sure neither Larry nor Mark were planning to become online advertising companies when they started off.

And sometimes these ideas literally start at the kitchen table.  Challenged by getting our young kids to eat their veggies, my wife Jennifer began playing a dinner game with them – points for eating colourful vegetables and fruits.  She eventually created a set of index cards and which turned into a card game that helps kids have fun eating a colourful, healthy plate of food.  Fast forward a few months and Crunch a Color has won a “Top 100” toy award, sold out its first production run in a week and been picked up by retailers across North America. 

My wife never set out to build a business, but she – like so many founders who start from the heart – might actually end up having a pretty good one.    

Replacing CEOs

I regret to say that I've personally served on a dozen boards of venture backed companies that have replaced CEOs. It's usually not a good sign. It doesn't mean those start-ups were doomed; but it does mean drastic change was needed.

The decision to replace a CEO is never taken lightly. Replacing any CEO is difficult enough. Replacing a founder/CEO is even more traumatic and fraught with risk.

Although I have never seen a case in which a CEO, even a founder, is indispensable, over the years, my partners and I have formed a strong preference for founders.

Most founders have never been a CEO. Some may have never even had a corporate job (Mark Zuckerberg, for example). Yet we prefer to work with them as they learn on the job. 

I won't get into why we prefer founders (not the main topic of this post) but I'd recommend checking out these articles discussing the merits of founder CEOs: 

• I first wrote about our preference for founders three years ago: Ousting the Founder 
• Ben Horowitz wrote this more recently: Why we prefer founding CEOs 
• Steve Jobs' Law: Why Founders Make the Best Leaders

When my partners and I first got started more than 15 years ago, we replaced CEOs quite often (though I'd esimate it was about average for the VC industry as a whole. I'll share actual data later in this post). In contrast, my eight most recent boards have yet to replace a CEO.

One data point which reflects the presence of founder CEOs in venture portfolios is CEO ownership. When we tell people that the typical CEO in an Altos backed company owns more than twice the equity of a typical venture backed CEO, they assume it's because we invest less money (resulting in less dilution). While this is true, the bigger factor is that most of our CEOs are founders.

On average, the minute a board replaces a founder/CEO, that company's CEO ownership percentage drops. For example, when Eric Schmidt was hired at Google, the CEO ownership stake dropped to 4%, far lower than Larry Page's stake. 

Another reason we replace CEOs less often is selection bias. We are less likely to invest in the first place if we believe a new CEO will be needed. I'm always surprised when a VC submits a term sheet that calls for the retained search for a new CEO from day one.

We'd rather not make an investment, if we don't know who the CEO will be. As the saying goes, "go with the devil you know versus the devil you don't." We must believe, at least in the beginning, that the person we're backing can develop into a great CEO.

In the case of backing a "professional CEO" we must believe that the person has what Warren Buffett calls "owner mentality" (it might not be as good as founder mentality, but it's better than most). 

Of course, this does not mean that we will never fire a founder or replace a CEO. We make plenty of mistakes. To see if we might learn from them, I decided to look at some data from our current and past funds.

After studying a data set of more than 60 companies, I found that the probability of a CEO change increases dramatically with each new round of financing, unless a company is already profitable. A CEO who can control her own destiny is much less likely to get replaced. 

Given that the companies in this data set have raised more than a billion dollars from over a hundred different venture firms, I suspect that there is a similar pattern for the entire VC industry, even if specifics vary from fund to fund. 

In the chart below, each bar represents a group of companies based on how many rounds of funding were required to get to profitability or exit. The height of each bar represents the percentage of companies that replaced CEOs. 

  In companies needing only one or two rounds to get to profitability or exit, CEOs were replaced less than 14% of the time. At the other extreme, if a company needed four rounds or more, the replacement rate sky-rocketed to 85%. For companies that required three rounds, the rate was 53%, which is about average for the industry (see article below). 

Given this data, I'd advise start-up CEOs to get their companies to profitability sooner. Control your own destiny. Otherwise, deliver an exit before you run out of money and have to raise another round. 

Other Factors:

When a CEO is replaced, the rationale is usually quite subjective. "The team has lost confidence" or "lack of leadership" are typical quotes from board members considering a change. 

For me personally, I've learned that my stress level about any particular company goes up and down with confidence in the CEO, regardless of how the company is doing. Let me try to explain. 

Even if a company is doing really well, if I do not have confidence in the CEO, I tend to worry a lot because things might fall apart; and sooner or later, the shit usually does hit the fan.

In contrast, even if a company is struggling, if my confidence in the CEO is high, I stress less because I know there is a smarter and more capable person staying up at night not only worrying about things but doing something about it. 

That said, other than obvious reasons such as lying, cheating or stealing, I believe the following are other, more objective, factors correlated with change in CEOs:

1. Time - eventually, all CEOs retire, die or get fired.
2. Lack of growth - a flat profitable business might be OK for some but not for VC backed companies that promised high growth to investors.
3. Employee turnover - higher than normal turnover happens for two reasons: great people are hired but are repelled or mediocre people are hired and must be replaced. Successful companies typically have turnover rates that are significantly lower than industry averages. 
4. Burn rate relative to cash balance (key metric we track is months of cash remaining)

More Data:

The following article has some interesting statistics. Out of 50 high-profile VC-backed companies in 2010, 54% had replaced founder CEOs: "Do VCs usually fire founder CEOs?" 

I'd also recommend checking out these questions on Quora for more info and discussion:

1. On average how often do founding CEOs get replaced by a VC controlled BoD?
2. How do VCs eventually come to the conclusion that they need to replace the CEO?
3. What skills does a CEO of a growing company need that a founder CEO might not have?

Final Note

I'd like to emphasize that the data points out a strong correlation, not causation. For example, it's possible that VCs are more likely to replace CEOs in companies that run out of money and have to raise more rounds. It's also possible (and very likely) that start-ups that hire professional CEOs tend to raise more money and go through more rounds of funding.

Founders are much more sensitive to dilution compared to professional management that are granted more options if a company goes through a massively dilutive round. Founders also want to maximize control. The biggest fortunes have been amassed by founders who have been able to retain quite a bit of control over their companies, sometimes decades after the IPO.

The punchline of the article should be "get profitable" rather than "avoid the 4th round."

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."

Passion

Fred Wilson wrote a post yesterday talking about Mission Based Businesses and how critical passion is to building a successful business.

Which comes first? Passion for a great mission or a successful business?

Conventional wisdom is that passion comes first (or is more important). I have a different point of view.

For every great business, there are countless well meaning, passionate entrepreneurs who don't make it.

Even great entrepreneurs can lose their passion. Tony Hseih, CEO of Zappos, is a great entrepreneur. In his book, Delivering Happiness, he shares how he lost passion for LinkExchange, his first startup, before selling to Microsoft.

There are good businesses and bad ones. One saying we have at Altos is "it's hard to fall in love with a crappy business."

To remain passionate, it's critical that you build a successful business. You will find that it is easier to fall in love with the business and love what you do.

I've observed many companies start with great missions that go nowhere. I've also seen companies grow their aspirations and missions to something far bigger than they had imagined in the beginning.

Rather than spending much time thinking about a mission to inspire employees and customers you don't yet have, focus on delivering a great product or service. Build a successful business. It all starts there.

Entrepreneurs like Bill Hewlett and David Packard did not set out to change the world. They just wanted  to work together. They built a product and started selling. They had no business plan. No grand mission. They took it one step at a time.

One final word about passion and love. The love you feel for a startup is like the passion in a new relationship. Such passion is intense but it can fade away.

What you want is the type of passion that grows in a great marriage. Marriage is tough. You have to work hard at it and you will go through many ups and downs. But in the end, you just might find true love.

Another Bubble

There is lots of talk about a new bubble forming...countless blog posts and discussions over the past year which I won't revisit. 

The latest theory is that the DST investment in Facebook in 2009 was the Netscape moment of the Web 2.0 era, which means this year might be like 1997 (two years after the Netscape IPO and another 3 years before a crash).

The thing about bubbles is that no one knows for sure. That's why we have bubbles...and pops.

Assuming we are headed into another bubble, some people are giving advice. They say that you should act differently during this bubble.

They will say "it's different this time" - an addressable Internet market of a BILLION people, cloud computing, mobile computing, titanic shifts in ad dollars, unprecedented growth in real revenues and profits, etc. 

To be or not to be lean?

The lean start-up movement has been terrific. Following the crash of the Internet bubble, a new generation of lean entrepreneurs, building capital efficient companies, was born.

But now people are confused. They are again debating the benefits of going fat vs. staying lean. Even some leading proponents of lean are advising entrepreneurs to behave differently (see Steve Blank's post on "new rules for the new bubble").

The problem is that changing your behavior with the times could a recipe for disaster. It is not honest either - certainly, not genuine or authentic.

Strive to do something which might stand the test of time. Do something which will last beyond the next bubble (and the inevitable crash).

Don't worry so much about what others are doing. Let them raise lots of money and spend it on PR or advertising. Why worry about things you can't control? Focus on what YOU need to do.

This will be hard to do. The behavior of everyone around you will change. You will feel new pressures from all around, even from very smart people and trusted advisors.

Here is an example - pressure to raise more money than you need. One of our portfolio companies was approached by prominent investors who wanted to "get in." They tried flattery (a very high valuation). Then they tried a threat (they may invest in a direct competitor rumored to be raising more than $100 million).

Try to resist such pressures. Resist temptation; and above all, resist envy. It is the most insidious of sins. Envy feasts on bubbles even more than greed or fear (of missing out). 

Don't fret about timing. People who try to time it get it wrong. They invest when things get hot. They pull back when things look bleak (i.e. buy high and sell low, even though they were trying to do the exact opposite thing).

Trying to take advantage of the greater fool, means, by definition, that you are a fool. That said, I do have some advice.

If you are going to sell your company, this is a pretty good time to do it. Valuations are high, buyers have cash, they are hungry and they are moving quickly.

If you need to raise money, now is a good time to raise it - equity or debt - the terms are favorable. But remember to be careful when taking advantage of this environment. The time to be cautious is when everyone else is bullish. 

The next few years will be very interesting...

Don’t Drink Your Own Kool-Aid

 

In my twenty years of working in and with startups, I’ve continually tried to figure out what makes some work and others not.  There are myriad factors of brilliance, determination, luck and timing that go into the success equation.  One of the most important and overlooked characteristics of successful entrepreneurs is objectivity: the ability to see and deal with reality in making decisions.

By their nature, startups are driven by passion, optimism, persistence, hope and dreams.  All these traits are essential to fueling the process of inventing a product and innovating a business model.  The beautiful thing about startups is that they are emotional and intellectual creations brought to life through shared vision and hard work.  

Company founders and CEOs get employees, customers and investors to take innumerable leaps of faith on the way to fulfilling their entrepreneurial visions. Mixing the Kool-Aid is an essential part of building a company (see also: eating your own dogfood).  But drinking your own Kool-Aid is the enemy of sound decisions. 

Here are three signs that you might be doing it:

1. Illusion: Some would say that most of the factors that drive success are outside of an entrepreneur’s control.  But most entrepreneurs suffer from the illusion of control - “the tendency for people to overestimate their ability to control events.”  This is as true for CEOs of small companies launching new products as it is for large companies planning corporate takeovers.  It is critically important to understand the difference between things you control and the things you don’t – and be clear and objective about that.

2. Hope:  Closely related to the illusion of control is optimism bias, or the "tendency for people to be over-optimistic about the outcome of planned actions."  While optimism is a fundamental part of entrepreneurism, its evil twin is hope.  The more desperate a company’s situation, the more you hear the word “hope” driving business decisions.  In a company meeting last week, my Spidey senses perked up when the CEO described the company’s next product launch in all-too-hopeful language.  He was “hoping” for vast improvements in four separate metrics (traffic, registration, engagement and conversion) to click in just the right way.  Did I want it to happen?  Absolutely.  Did I think it would?  Absolutely not.  As the old saying goes, “hope is not a plan.”

3. Spin: Good spin is essential to marketing your product to the world, but behind closed doors with your team or your board, you have to be brutally honest about the facts.  Startups are all about learning, and if there’s even one degree of spin on the data, it’s hard to learn the right lesson.  If your board meeting agenda looks like an actuarial recitation of facts and metrics, you’re on the right track.  If your board meeting agenda looks like a pitch deck, you’re not being objective.  Beware of underestimating competitors.  Beware of prematurely declaring victory.  Beware the phrase “conservative projections.” 

How can you avoid drinking too much of your own Kool Aid?  Here are a few ideas:

1. Metrics:  My investor friend Dave McClure is piratically fanatic about metrics.  Follow his advice: get religious about metrics.  Bad decisions thrive on incomplete data, speculation and opinion.  My favourite companies post their metrics up on big screens for everyone to see. The more you can instrument your business, the fewer places there are for bad decisions to hide. 

2. Culture:  As a leader in a company, it is critical to create a culture that allows for open, fact-based dialogue and dissent.  Highlight team members who get it right while being honest and self-deprecating about your own bad decisions.  Celebrate unconventional ideas.  Designate someone on your team to take the devil’s advocate role.  Beware groupthink. 

3. Friends: Friends don't let friends drive drunk.  And your good friends, your real supporters in the entrepreneurial enterprise, should not let you fool yourself either.  Don't surround yourself with people who just reinforce your worldview.  Surround yourself with advisors and investors who are honest enough to call bullshit.  But don't confuse brutal honesty with a lack of enthusiasm for you or your business.  It is absolutely necessary.

Every entrepreneur needs to mix some pretty strong Kool-Aid to persuade employees, customers and investors to come along for the fantastic ride of building a new company.  But the really great entrepreneurs know not to drink their own.

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. 

25 Heat Seeking Missiles (and 10 Key Lessons)

First Round Capital's Josh Kopelman recently wrote a great post talking about entrepreneurs as heat seeking missles. Here is an excerpt:

I've lately started to realize that our most successful companies are led by entrepreneurs who have a unique talent -- they are heat seeking missiles.  It doesn't matter where the missile is aimed pre-launch.  Successful entrepreneurs are constantly collecting data -- and constantly looking for bigger and better targets, adjusting course if necessary.  And when they find their target, they're able to lock-onto it -- regardless of how crowded the space becomes. 

At the end he says

You can't predict success based on where a missile is pointed pre-launch.  Instead you have to assess the quality of the targeting system (the team) and the density/size of targets (the market).

He makes a great point. If you want to read about many more "heat seeking missiles," I’d recommend a book called “Retail Superstars” by George Whalin (http://www.retailsuperstars.com/) which talks about 25 great entrepreneurial success stories.  

I LOVE observing and studying great retail entrepreneurs because there is nothing quite like the retail business. There is no other business which puts entrepreneurs in front of customers so close, so personal and so often. I grew up in a retail environment. My mother owned franchised Hallmark Card and Gift shops and I remember chipping in, working every Christmas season, helping customers and gift wrapping thousands of presents over the years. Depending on the person and who the gift was for, I often made small, last minute adjustments on the type of wrapping paper, ribbon or knot (also, I did it to keep it more creative and interesting).  

The book essentially describes 25 great entrepreneurs (and their families, since most are family-run) and the story of how they built fantastic businesses which have not only survived but thrived in this most recent era of retailing dominated by Wal-Mart and big box retailing. 

The assault on independent store operators (most of which are run by entrepreneurs) didn’t just happen with Wal-Mart (which got started in the mid 1960s). There is a book called “Chain-Store Retailing 1859-1950” which chronicles how chains such as Sears, Montgomery Ward and JC Penny began spreading across America putting local merchants out of business along the way. The chains were becoming so powerful that in the 1920s and 30s, some communities and even states enacted laws to limit the number of new stores by chains.

The "retail superstars" defy conventional wisdom and epitomize the “think different” approach that all great entrepreneurs take. They provide proof that great entrepreneurs can succeed, against all odds, in ANY market against even the toughest competition.  The book is truly inspirational (if you love and admire entrepreneurs).

The top 10 lessons and common traits across the 25 retail superstars are:

1. There was no up-front plan or even long term vision. “When asked whether their companies had been built based on a business plan or set of guidelines, they invariably answered no, their growth was guided by what customers wanted and expected from their stores, what the marketplace dictated, and how they could best serve their customers.”
2. They got started with no outside funding - and ALWAYS with very modest stores, or sometimes no store at all - like selling fruit out of a cart. They all became hugely successful, one modest step at a time.
3. They are scrappy survivors. Many suffered disasters, even death as some businesses moved from generation to generation, yet they all kept growing.
4. They hired great people (friendly, knowledgeable staff) and kept them for a long time (which is unusual in retailing). They took care of their people who, in turn, took good care of their customers.
5. They embraced change and instilled a culture within their companies to allow staff to innovate and adapt to the needs of their customers and communities.
6. Even as circumstances changed, they maintained long term relationships both inside and outside of their stores. Repeat customers and word of mouth advertising fueled growth in each business. They figured out viral marketing long before it was so hip.
7. Surprisingly, they used technology to their advantage. Technology is just a means to an end. Most used the Internet and social media to engage their customers and broaden their reach (before the Internet, they used catalogs and direct mail). Every single business in the book grew with an absolute focus on the customer. If technology is useful for that purpose, it should be used.
8. They all gave back. Each retailer were pillars of their communities and incredibly generous to various causes around their communities with not only money but time and thoughtfulness.
9. They defied conventional wisdom and showed that there are many ways to succeed. Some retailers had great selection and huge stores. Others were focused and had very small stores. Some retailers offered great value and led with price. Others catered to the very high end and would give you sticker shock! Some operated in very big cities and big markets. Others operated in very small towns in the middle of no where where customers would have to drive miles to visit - yet they all built very successful, growing businesses.
10. A company can lose its soul when hired guns (i.e.“professional management”) take over. Home Depot was a fantastic entrepreneurial success in its growth phase when it started out employing skilled carpenters, painters, plumbers and electricians to work in its stores. “They served their customers well and the company grew into the largest home center retailer in the country. When management changed and a take-no-prisoners, cost cutting approach was adopted, most of those full-time craftsmen got caught in the cross fire. Without skilled employees, Home Depot’s sales suffered and its sterling customer service reputation was tarnished.”

One great retailer not covered in this book is Borsheims in Omaha, which operates the largest jewelry store outside of Tiffany's in NYC. It's the place Bill Gates flew his private jet to to pick out a ring for Melinda (their buddy Warren Buffett owns it). Nebraska Furniture Mart is another great retailer, also in Omaha, and also owned by Warren Buffet's Berkshire Hathaway. 

Woodman's is one of my favorite success stories of all time. No book has been written about them, unfortunately. They are an employee owned chain of grocery stores in WI and IL and have built a $1B+ business that has been evolving and growing for decades and will continue to kill the local Safeways, Whole Foods and Wal-Marts (http://www.woodmans-food.com/). One can learn a lot about how to compete and run a defensible business by studying a company like that. 

One of my favorite retailer-entrepreneurs, Barnett Heltzberg, wrote a book called "What I Learned Before Selling to Warren Buffet." I've blogged about him in the past and it's worth a quick read if retailing or entrepreneurship fascinates you. His key lesson was "Focus on the Controllables" (http://www.blog.altosventures.com/vc/2007/06/the_controllabl.html).

Finally, one of my favorite entrepreneurs of all time is Sam Walton. There have been so many articles and books written about the man as well as his company but the one I'd recommend is "Made in America." 

The Fourth Wave

A few days ago, Michael Arrington posted The Third Disruptive Wave in which he postulates we are entering the Age of Facebook. He later goes on to say that the "Third Wave is happening, but that doesn’t mean that Facebook, Zynga, Groupon, Twitter and a few others are the only winners, or even the biggest winners. Facebook may have created a monster that it simply cannot control, for example."

Before commenting on Arrington's post, I'd like to point out that we are in the FOURTH wave, not the third. In my opinion, each wave of disruption in the computer industry since the invention of the PC is easy to identify because the era was defined by a company which reached a market cap of $100B+ faster than any in history.

In the 1980s, Microsoft grew in dominance to become the fastest company to reach $100B market cap. It took 25 years (11 years to IPO). Casualties along the way were IBM, Wang, DEC, Novell, Lotus, Word Perfect, Apple and many others. 

In the 1990s, Cisco grew in dominance to become the fastest company to reach $100B market cap. It took 14 years (6 years to IPO). Casualties along the way were IBM, 3Com, Bay Networks, AT&T/Lucent, Alcatel, Nortel and many others. Cisco helped fuel the golden age of venture capital by acquiring more than a hundred VC backed companies (and propping up valuations and exit prices of hundreds more). 

In the 2000s, Google grew in dominance to become the fastest company to reach $100B market cap. It took them 8 years. Casualties along the way were Microsoft, Yahoo, AOL and many others. (Interestingly, during the same decade, Apple was reborn and created even more value than Google as it grew from $16B to $200B market cap). 

So, in this decade, in the middle of the FOURTH wave, which startup will grow to become the next $100B company? The obvious answer is Facebook. HOWEVER, if the question is which company will shatter Google's record for fastest to reach $100B market cap, the answer is not so clear. 

Facebook is already more than 6 years old. Even if they reach $100B market cap within the next 2 years, it will NOT shatter the record. Remember, Microsoft crushed the prior record by decades. Cisco got there 11 years faster. Google got there 6 years faster. Each new record holder got there more than 40% faster. 

What's amazing to contemplate is that, during this decade, we may see a company start from scratch to reach $100B market cap in seven years or less. 

We are indeed entering an exciting age and it's not at all clear that the winner of the FOURTH wave will be Facebook. As Arrington noted, "Facebook may have created a monster that it simply cannot control." 

As a VC who has lived through the 1990s and 2000s, I am more excited than ever about the tech industry. The pace of innovation and growth of great new products and companies has been mind boggling (see Arrington's post for recent examples). 

As we look back, the 1990s was fantastic for VCs and entrepreneurs. The 2000s were tough - really tough. In the decade ahead, we might see another fantastic run by VCs and entrepreneurs as fund sizes shrink, capital efficiency comes back in vogue, and the pace of innovation and value creation continues to accelerate. It'll be fun to see how it all plays out.