Category Archives: strategy

The Simple, Definitive One-Step Hot Market Test

Posted on March 22, 2012 | 1 Comment

Founders, entrepreneurs, venture capitalists and startup employees often spend a lot of time wondering, worrying, and pondering if a company is in a hot market.  Will the company shoot the moon?  What is the market potential?  Are you in Geoffrey Moore’s tornado?

After 25 years or so doing high tech companies, I have a simple test:

If you have to wonder whether you are in a hot market, you’re not.

It’s really that simple.

That’s not to say that re-positioning / pivoting into a hot market is impossible.  But I have always believed the biggest strategy problem most companies face is not “step 2” — i.e., determining strategy given a situation assessment.  That’s actually not that hard.  Step 1, however — figuring out your market situation — is the killer.

Companies get it wrong because people are optimistic.  No one wants to call the baby ugly.  People confuse the potential to be in a hot market in the future with being in one in the present.  (If we just sit here, maybe Prince Charming will come along.)  And people want to believe that changing markets is as easy as putting { mobile | big data | social | analytics } lipstick on the proverbial pig.

Because the prospect of not being in a hot or soon-to-be-hot market is too grim to ponder (and/or too politically incorrect an assertion to state), companies tend to always assume that they are in a hot market.

I remember visiting an empty building with 2 guys sitting  atop a $30M venture capital sinkhole.  “We’re in big data.  That’s a hot market.”  That was funny I thought.  I didn’t think of them big data.  And I was on the board of Aster Data, one of the original “big data” companies.  And if you’re in a hot market, why is the building empty?

It’s also not to say that you can’t build a nice company or get a good return for your investors if you are not in a hot market.   Many strategies — mostly focused on developing series of market niches — can be successfully applied in these situations.

But if you get the situation assessment wrong, you’ll never correctly arrive at the right strategy for it.  (And hoping for offsetting errors isn’t a good approach, either.)

I’ve spent about 18 years of my career working in hot markets and about 8 in cold ones.  I’ve also advised a handful of companies over the past 4 years, some in hot markets and some in cold ones.  I can tell you there is a difference.  A difference so obvious that I am positive that the only people who wonder if they are in hot markets are the ones who aren’t.

If you’re in one, you know.

→ 1 Comment

Posted in strategy

The Future of the Company

Posted on March 8, 2012 | 10 Comments

It’s fairly common to hear the CEO of a company that makes most of its money doing thing-X announce that the future of this company is thing-Y.

Why might they do this? I think it’s often just to sound visionary and bold. In rare cases it might be a clever plan to distract thing-X challengers by redefining the competitive agenda to include both things X and Y (Oracle excelled at this with many failed initiatives such as the NC).  There are certainly also cases where markets go bad and must be exited, such as when Intel needed to flee the commoditizing DRAM market.

But in the embrace-change-or-die culture of Silicon Valley, there’s also something fashionable about saying, “I know we are the leaders in thing-X. But thing-X is not strategic enough. So the future of this company is thing-Y.”

It takes guts to say it. TechCrunch and the VCs will get goosebumps.  There’s a certain burn-the-ships attitude that one can’t help but admire.

But is a good idea? I think, for the most part, no.

While it is sometimes absolutely necessary to lead companies through major transitions, I think the “future is Y” tactic is overused and often misapplied.
Sometimes burning the ships drives a high level of commitment to developing a fertile new world. Sometimes, however, it leaves a bunch of starving sailors on a barren rock.

My two favorite examples of this principle are Ingres and MarkLogic.

Let’s do Ingres first. Ingres was founded in 1980 about 2 years after Oracle and was one of the original 4 players in the relational database market. For a bevy of reasons more related to marketing and strategy than technology, Ingres lost the early relational database wars to Oracle. For example, by 1992, Ingres was struggling $240M division of the $400M struggling applications vendor ASK, while Oracle dominated the market and was about $1.2B. Somewhere around 1989 or so, it became clear to Ingres that they couldn’t win the core RDBMS market. In an epic display of bad decision-making, the company declared that the RDBMS market was commoditizing and decided to strategically focus on application development tools. I remember hearing top management say “the future of this company is application development tools.”

This was a terrible decision for several reasons:

  • The RDBMS market was still in its infancy. Today, it’s a $15B (per year) market. Literally, hundreds of billions of RDBMSs were sold subsequent to Ingres’s decision that it was a poor market. It was in the top-two market opportunities for IT in the last century. (The other being PC operating systems.)
  • The RDBMS market was not commoditizing. Ingres confused the growing dominance of a standard query language (SQL) with product commoditization. The products were all quite different. SQL would be extended and, in effect, re-made proprietary. The market wasn’t trending to pure competition and commoditization; it was headed towards oligopoly. Oracle drives 50%+ margins in RDBMS.
  • The notion of carving a segment off the market was never considered. When someone loses the battle for dominance in market A, you don’t need to move to market B; you can segment the market instead. For example, Ingres was always very strong in query optimization. As Ingres was bailing out of RDBMS, a new multi-billion dollar segment was opening in databases specific to data warehousing, where that optimization technology would have been critical. Open source was another option was hiding in plain sight (the original University Ingres was always open-source; even before the term or concept was widely in use).
  • Application development tools were a non-attractive market maybe 1/5th the then-current size with low barriers to entry, boatloads of competitors, strong downward pricing pressure (e.g., free runtimes), a powerful entry Visual Basic / Visual Studio and a bevy of other PC-based tools.
  • The statement, and accompanying reallocation of resources, alienated all the database people who thought “why do I want to work at a database company not committed to databases?” The answer was you didn’t. Many of them ended up at Oracle and Sybase.

Tools were indeed the future of Ingres and that future ended up pretty bleak. In 1994, the whole struggling ASK/Ingres mess was sold to CA for $311M, a fraction of annual revenues.

Now, let’s look at MarkLogic. MarkLogic was founded in 2000, to create a hybrid DBMS / search engine based on the XML data model and the XQuery language. In 2003, Gartner wrote a note called XML DBMS: The Market That Never Was. Despite that, I joined the company as CEO in 2004 because, while I was aware that there was no horizontal momentum for the XML DBMS category, the company did have outstanding technology, strong investors, a great team, and a handful of good early customers.  I strongly believed it was a classic case of where a “bowling alley” strategy could be applied successfully.

(A bowling alley strategy is a systematic vertical market development strategy described in Inside the Tornado by Geoffrey Moore. The idea is simple: in the absence of strong category momentum, a vendor can be successful nevertheless by focusing on specific needs in specific industries and then bridge across markets by solving similar problems in new industries or new problems in the same industries.)

To me, it was clear cut and, God bless Geoffrey Moore, it worked. Of the dozen or so XML DBMS vendors in existence in 2004, the only one who succeeded in building a real business was MarkLogic. Some went out of business. Some repositioned into XML publishing applications. Some were sold for a pittance.  Do you remember any of these names:  Tamino, Ipedo, x-Hive, TigerLogic, Ixiasoft, Xyleme, eXist? It wasn’t exactly a hot category.

Despite the fact that 90%+ of the revenue was coming from the media and government verticals, several “important people” persisted in believing that the future of the company was enterprise. (Meaning, selling horizontally to F1000 IT.)  I never liked that because a horizontal enterprise assault had played no role in the company’s success to that point, and the data I saw suggested that wasn’t going to change in the future. To me, anyone paying close attention to the present might well conclude that if enterprise were the future, then that future might be pretty bleak.

Several things happen when leaders of thing-X companies declare the future of the company is thing-Y.

  • You make counter-intuitive investment decisions. For example, if I told you that thing-X salespeople sold $2M/year and thing-Y salespeople sold $1M/year, you might expect that a company would consist of 100% thing-X salespeople. (For a given number of salespeople that maximizes revenue.) But once thing-Y is declared strategic, the company will seek to hire more of the lower productivity salespeople to support the strategy.
  • Thing-X employees feel disenfranchised. I’d always felt that Oracle never forgot it was a database company. No matter the timeframe,  a top database engineer was a prestigious job. At Ingres, after about 1989, it wasn’t prestigious to be in the database group. Oracle never said tools or apps were the future of the company. Oracle, in effect, said: we are the leader in database and will leverage that to expand into tools and apps.
  • Thing-X customers can potentially get rattled. I’m told that at the first MarkLogic User Conference after I left, that new management explained to an audience almost composed of media and government customers that the future of the company was enterprise.  It’s risky to treat your customers like your high school sweetheart on the day you went off to college.  (Hasta la vista.)
  • Your best employees will want to move to thing-Y. By saying the future is thing-Y, you are announcing to your team that the past is thing-X. Your best and brightest will quickly get the message that to maximize their career opportunity, they should be working on thing-Y.

I firmly believe that there are situations where companies must leave an old market and enter a new one. Cognos’s exit from mid-range application development tools into BI is a great example. In 1996, you could safely say that the future of Cognos was BI. I’m sure that created many transition issues internally for them and, for the record, I believe that Cognos managed those issues extremely well. But given what was happening to VAX/VMS and MPE/XL Cognos had no choice. They needed to burn the ships and move to a new world.

But for, the most part, I believe that VCs, board members, and executives make one of two mistakes when they say the future of a thing-X company is thing-Y.

  • They are hoping the future is thing-Y because for some reason they find that market more attractive than the market for thing-X. Often this may be a case of boredom with your own market (i.e., grass-is-greener syndrome) or a lack of creativity in developing it. Recall that Google was in part born by Yahoo declaring search non-strategic, and instead choosing to focus on portals and content.
  • They are creating an artificial rhetorical “or” for dramatic purposes when the real message should be “and.” Follow the Oracle model instead:  we are going to lead in databases and, by hook or by crook, we are going to build an applications business because we believe that both are strategic to our future.

So the next time you hear anyone say the future of your company is Y, challenge them. Ask about X. Ask about Z. Ask about X and Y as opposed to X or Y. Then consider the real consequences of having your entire organization — and customer base — truly believe that the future is Y.

If you like that picture, stick with it. If you don’t, think a bit harder and change the plan.

→ 10 Comments

Posted in strategy

Bobby Fischer Applied to Silicon Valley: Pattern Matching vs. Good Moves

Posted on July 26, 2011 | 4 Comments

When asked why he won so many matches, chess grandmaster Bobby Fischer would reply:  ”all that matters on the chessboard is good moves.”

That is, winning is all about the moves.  And moves, in turn, are all about the situation.  Contrast this to today’s Silicon Valley fashion of “pattern matching” which seems the opposite — all about the players and not so much about the moves.

Consider Blippy, a bad idea if there ever was one, which created a $13M VC sinkhole for a service to share credit card receipts on your social network.  Let’s look at the founders:  two recent Stanford engineering grads and an experienced entrepreneur, Philip Kaplan (most famous for bubble-era website,  F**kedCompany).

How about Cuil?  (Pronounced coo-il.)  Cuil launched in July, 2008 claiming to be the next Google with superior indexing and operational cost advantages.  It seemed clear to me (and the world) that from the start, Cuil wasn’t any better than Google.  They burned $33M in VC and entered theTechCrunch deadpool in Sept, 2010.  Let’s look at the founders:  three ex-Google engineers, two of them PhDs and one from Stanford.

When pattern matching is the rage, when the moves are so obviously bad, and when the players so clearly match the pattern, I’d argue that Blippy and Cuil broke Fischer’s law.  They weren’t about the moves; they were about the players.

I used to joke that if you wanted to raise money in Silicon Valley you should be aware that VCs see people in one of four buckets:

  1. Made me money before.
  2. Made someone money before.
  3. Went to Stanford
  4. Everybody else

Now, make no mistake, the team is has always been a key factor in venture capital investment.  But I think the historical approach was to see the team as de-risking element for the idea.  Put differently, we are investing in a market opportunity and we would like to isolate as much risk as possible to the market opportunity.  How do we do that?  By getting an experienced executive team to reduce execution risk, by hiring experienced engineers to reduce product development risk, etc.  That is, as VC founding father Don Valentine used to say, “great markets make great companies.”

(Asides:  [1] Irony alert in the above video where Don tells a bunch of Stanford graduate students it doesn’t matter where they go to school and [2] note further that Valentine was a pithy quote machine, coming up with such classics as “I am 100% behind my CEOs up until the minute I fire them” and “all companies that go out of business do so for the same reason – they run out of money.”)

Somehow I wonder if things haven’t gotten upside-down of late:  where the players matter more than the moves.  I’d argue that Silicon Valley used to be about the moves (the strategy and market opportunity) and VCs sought experienced players as a risk reduction technique.  Now, it appears to be about the players and the implicit assumption that those who match the player-pattern can win any match, regardless of the moves.

→ 4 Comments

Posted in strategy, Venture Capital

Marketing Vision While Selling Product: The 3+1 Repositioning

Posted on July 15, 2011 | 1 Comment

This post was inspired by a recent beer with long-term colleague, friend, and fellow volleyball dad, Paul Albright, now chief revenue officer at Marketo.

The question we discussed was how can a company sell current product capabilities but also market vision at the same?  (For brevity’s sake I mean “product” to include either traditional software products or SaaS / cloud services.)

Most companies simply market their current product capabilities:  Here we are.  This is what we do.  Here are the benefits of using it.  Wanna buy one?

While this isn’t bad — particularly if you don’t forget step 3 (benefits) — you can do better.  How?  Say, for example, your competition sells an offering similar to yours and they sell using a current capabilities patter similar to the one above.  Now you show up selling something bigger:

 This is our current offering and it includes area 1 (which the other guy is pitching), but also areas 2 and 3, and the vision for our company is not just about having the best area 1, but instead to pursue a capstone vision that includes areas 1, 2, and 3.

Ceteris paribus, who do you think wins?  You do.  Why?  Because you completely enveloped the other guy’s message.    You neutralized him on area 1, you one-upped him in areas 2 and 3 (even if your current offering is anemic on an absolute basis), and then you made the customer feel both more aligned with and safer buying from your company because you are pursuing the bigger vision.

I call this a 3+1 repositioning.

I did my first 3+1 repositioning  back in about 1989 when I launched Ingres 6.3.  Prior versions Ingres were just for data management, but with release 6.3 we not only improved data management, but added knowledge management and object management capabilities and introduced the vision of an intelligent database system.  So area 1 = data management, area 2 = knowledge management, area 3 = object management, and the capstone vision was the intelligent database.  While it was a well-executed launch, it was a long time ago, Ingres had many other problems, and the ending wasn’t terribly happy.

So let’s look at some more recent examples.  SuccessFactors (where Albright was CMO and GM for several years) started out as a SaaS provider of performance reviews. How do you broaden that vision?  Well let’s look at what they say now:

Now let’s take a look at Marketo, a firm that I have traditionally thought of as about lead nurturing and incubation.

The magic of the 3+1 repositioning is:

  • It paints a broader vision, enveloping your competition
  • It provides a simple, memorable three-point message.  (Heck, I launched Ingres 6.3 more than 20 years ago and still remember the message!)
  • It lets you call higher, getting access to more power within the organization
  • It positions your company as a thought leader, someone defining the future of the market
  • It takes for granted your ability to neutralize any features du  jour in the core area.  (Oh, yes, we’re committed to having top-end lead management, but that’s just one part of the picture.)
  • It rallies your company, providing a North star towards which everyone can navigate.

The perils of a 3+1 repositioning are:

  • It can’t be done solely are a marketing exercise; it must be a company strategy and some resources must be invested in areas 2 and 3.
  • You can easily oversell areas 2 and 3, ending up with disappointed customers.  Remember the bear joke:  you just need to run faster than the other guy, so don’t overset expectations.
  • It can make your accountants nervous because there is a distinction between buying today’s product and buying into a (disclaimed) future vision and buying tomorrow’s product.  The latter tends to have negative revenue recognition issues.

In the end, I am a big fan of this 3+1 formula and encourage marketers everywhere to keep it in your toolbox.

→ 1 Comment

Posted in Marketing, strategy

The Silicon Valley Strategic “Pivot”

Posted on July 13, 2011 | 6 Comments

The first time I heard the word “pivot” in the context of business strategy was about nine months ago.  As a student of language, my ears perked up when I heard it.  I remember thinking, “pivot … interesting, haven’t heard that one before, … strong buzzword potential, … nice metaphor, with one foot stationary and the other moving.”

Silicon Valley being Silicon Valley, with more fashion around language than clothing, today you hear it all the time.  Some sample usage:

  • “Yeah, dude, we had to pivot after our A-round, but after that we really got traction.”
  • “I think you know like, we’re running on our 401k round, just trying to figure out the core product, then we’ll expose it to the market, through a pre-alpha and pivot from there.”
  • “Like, you know, every startup needs to  pivot like two or three times before locking-in on its final strategy.  That’s the nature of innovation.”

Extending the metaphor, one wonders in the last example if your board can call the CEO for strategic traveling.  

Despite my general buzzword aversion, I like the pivot metaphor precisely because one foot is stationary.  A complete strategy change is therefore not a pivot but a traveling violation because you entirely abandon the old strategy as opposed to changing direction in a way that leaves one foot in the old strategy and one foot in the new.

I also like the pivot metaphor because I agree with the idea that from inception to $100M that a company will need to pivot and probably a few times.  (Think pivoting multiple times in a game, but not on one ball.)  That truly is the nature of innovation and Silicon Valley companies do it all the time.

The two interesting questions then become:

  • How do you know if you’re traveling vs. pivoting?
  • How you know if the pivot worked?

I answer the first question by evaluating the degree of continuity between the old and the new strategy.  I’d evaluate the second question by the revenue and margin contribution of the old strategy vs. the new one.  If the old strategy is driving all the revenue, then you may have pivoted, but it’s not working.  If the new strategy is driving the lion’s share of revenue and margin, then — and only then — have you done a successful pivot.

→ 6 Comments

Posted in Silicon Valley, strategy

Interest Misalignments in Silicon Valley Startups

Posted on June 8, 2011 | 14 Comments

Everyone’s aligned in a Silicon Valley startup, right?  Give everyone some options so everyone has skin in the game and then everyone wants what’s best for the share price:  one for all and all for one!

Not so fast.

In this post, inspired by a chat with longtime serial entrepreneur Ken Ross, I’ll delve into what I see as the common alignment issues in Silicon Valley startups.  While I am a big believer in broad employee share ownership, one shouldn’t make the mistake of believing that simply because everyone has shares that they are automatically and permanently aligned.

In my estimation, there are four drivers of potential misalignment.

  • Portfolio theory
  • Shareholdings and net worth
  • The “exit” concept
  • Irrational considerations

Portfolio Theory

The most common cause of misalignment is driven by portfolio theory.  VCs typically invest in 10-15 companies and work in partnerships of 5-10 partners.  Thus a VC might get “carry” (i.e., a slice of the investment profits) on 50-80 companies.  A friend once calculated that a VC gets the equivalent of a VP-level (or better) equity stake in each of the portfolio’s companies.

Entrepreneurs and executives, however, have but one life to give and must work at one company at a time.

Divergence can result when VCs want to take more risk than founders and executives because they have placed 80 bets while the executives have placed one.  This can manifest itself in pushing for overly aggressive operating plans or declining “base hit” acquisition offers in favor of “swinging for the fences” each time.   Time can compound this divergence as accumulated sweat equity tends to make the founders and executives more conservative over time.  (Think:  ”I have 8 years of my life in this thing, we can’t take that risk.”)

In addition, VC is increasingly a “hits business” – i.e., a fund that delivered an IRR of 35% might deliver only 15% excluding its top two investments.  Thus, VCs are generally more afraid of selling too early than too late.  While founders often tell tales of VCs declining early acquisition offers that could have earned them a quick $20M, VCs might tell the tale of VMware, which sold for $625M in 2004 and is now worth $41B.

Portfolio theory has other effects that are more subtle.  You might think of a given venture-backed company as in one portfolio.  In reality, the company is in numerous “portfolios” at different levels:

  • The fund level.  The expectations for a company become a function of the performance of the other companies in the fund.  If they are performing poorly, pressure may increase to deliver a big result.  Alternatively, if the fund is old, has lackluster performance, and the VC firm has subsequently launched several high-performing funds, a lack of interest may develop.
  • The partnership level.  Different VC firms set have different investment objectives and reputations.  Some want to quietly deliver great returns.  Some favor operating guys as partners, other favor financial types.  Some like seeing their name in the press; some don’t.    As a general rule, the more early-stage and the more big-name the partnership, the more they will want portfolio companies to swing for the fences across the entire portfolio.
  • The partner level.  Each partner in a fund has his own set of companies.  VC partners track each other’s performance closely and a partner’s fate over time is, in large part, determined by his investment performance.  In addition, since most VC firms are fairly stove-piped, expectations for a given company are probably more shaped by its partner’s portfolio than any other.  Factors that influence the partner’s motivations include the performance his portfolio, his existing status in the firm (e.g., venture partner looking for a big-hit to make general partner, or established leader in the firm, or in-trouble and need of a big-hit to stay in the game), and his future plans (e.g., retirement).
  • The partnership-partnership level.  Suppose early-stage VC firm 1 does a lot of business with late-stage VC firm 3, as is often the case.  You can then think of your company in the “intersection” portfolio between these two partnerships.   Why does this matter?  To the extent that VC3 is dependent on VC1, they may make decisions that optimize the VC1/VC3 relationship over those that they might think best for a given portfolio company.  (Think:  “if Bob ever wants to work with us again, he’d better go along with us on this decision.”)

Shareholdings and Net Worth

The size of someone’s position, particularly relative to net worth, can cause a divergence of interests.  Consider a hypothetical company with 25M shares:

  • The founder owns 5M shares.
  • The total employee option pool is 5M shares.  (Of which Joe Engineer has 20K shares.)
  • VC1 owns 10M shares, having paid an average of $1.60/share across two rounds.
  • VC2 owns 5M shares, having paid $3.00/share in leading the second round.

Let’s consider a proposed $6.00/share offer for this company, for a total exit of $150M.

  • The founder would make $30M and be set for life.  He votes yes.
  • VC1 would receive $60M which does not move the needle relative to the size of his $600M fund.  On a return basis, he makes 3.75x, a poor result for an early-stage VC.  He votes no.
  • VC2 would receive $30M which moves his needle even less.  He makes a 2.0x return, low for a late-stage investor.  He votes no.
  • Neither VC partner will gain any bragging rights because the exit is small in an absolute sense.   This confirms their no votes.
  • Joe Engineer would get $120K pretax or about $60K post-tax.  He can buy nice car, but he still can’t touch a Silicon Valley house.  Joe doesn’t get a vote, but if he did, he’d vote no, too.

The interesting thing here is that Joe Engineer is much more aligned with Winston the VC than he is with the company’s founders and executives.  Joe would vote no for two reasons:  first, $60K after tax doesn’t move the needle for him and odds are (since he chose to work at the startup), Joe is a true believer in the technology and thus thinks of this deal as sell-out.  Amazingly, Winston votes no for the same reason:  $60M doesn’t do much for his fund and he also sees the deal as a sell-out.

Now, the founder would have made $30M and, using typical ratios, the CEO would have made $7.5M, and the key VPs somewhere between $1.5M and $3.0M.   In most cases, they would all vote yes.  (But in reality only the founder and CEO are on the board and actually get a vote.)

The scenario changes dramatically if the founder is already rich.  Imagine the founder made $100M on his previous startup.  Now, a $30M exit is uninteresting because it results in neither a lifestyle upgrade nor a status change.  Now, the founder aligns with Winston and Joe in voting against the deal.  You can analyze the CEO’s vote in a similar fashion.

The “Exit” Concept

Managers want to build great companies; VCs want great exits.

Unfortunately, building a great company is neither a necessary nor sufficient condition to enable a great exit.  At only 3 years old, Bebo sold to AOL for $850M.  A spectacular exit, no doubt, but a little more than 2 years later AOL sold it for less than $10M.  A great company?  Certainly not.  YouTube, while infinitely more ubiquitous, barely makes money but was sold to Google at 18 months old for $1.65B.  A great exit?  Yes — goosebumps quality even.  A great company?  Not.

The best managers tend not to focus on great exits.  They focus on building great companies.  In fact, the “IPO as exit” is almost purely a VC notion.  In reality, an IPO is almost certainly not an exit for the CEO; he or she is de facto bound to the company for at least the next several years and his/her ability to sell shares is highly restricted.

I have always believed that IPOs are like high-school graduations – they are a beginning, not an end.  Godfrey Sullivan, CEO of the red-hot company Splunk, seems to feel similarly, saying “we consider an IPO the 3rd mile of a marathon. The IPO is an early milepost, not the destination.”

In the best-case scenarios, building a great company will indeed lead to an IPO which will be yet another milestone in a long journey of success.  But this is not always the case.  I’ve seen companies (e.g., Versant back in the day) twist into pretzels to make it through the IPO window and provide a reasonable exit for the investors only to end up living-dead zombies thereafter.

Now, I have not found the particular VCs with whom I have worked over the past 20 years particularly exit-focused.  Most are surprisingly patient and indeed want to focus on building great companies.  But, you cannot ignore the possibility of divergence when some of the passengers can exit the bus reasonably quickly post-IPO while others cannot.

The terminology “exit” reflects this pretty clearly.  For employees, customers, staff, and executives, the IPO is not an exit.  Nor, for that matter, are most acquisitions.  Founders, key executives, and key staff are often locked in (through various mechanisms) for 1-3 years after a deal closes.

Irrational Considerations

As humans, we must recognize that we do not always act rationally.  Behavioral economics reminds us that we are subject to a bevy of rules and heuristics that can cause us to make sub-optimal decisions.

Some decisions that appear irrational are rationally motivated  – but by either an unknown personal or non-shared goal.  Others actually are just plain irrational.  For example:

  • Anchoring:  I need to make $50M.  (Because I decided that I need to make $50M.)
  • Benchmarking:  I need to make $50M.  (Because my roommate at Stanford made $50M and I’m smarter than he is.)
  • Fame-seeking:   I need to be famous and will take increasingly risky bets in order to achieve that.  (Arguably this is a rational decision derived from a non-shared goal, but if you are on the board of a company you have a duty to its shareholders so I’d argue it’s irrational from that perspective.)
  • Dreaming:   This technology is going to change the world, despite much evidence to support that contention.  (Because I made it and it’s really cool.)
  • One-more go:  I will take increasingly risky bets because I’m retiring soon and this is my last chance to get one more for my legacy.  Shoot the moon.

The trick here is most founders are, by definition, a little crazy.  The confidence and zeal it takes to quit one’s job, develop a product idea, start a company, and raise venture capital is well beyond that of the average “reasonable” person.  Thus, it can be hard for founders to know when to stop pressing bets.  The same traits that enabled them to be successful as founders present a risk they overplay their hands, and destroy shareholder value in the process, in the long term.

Conclusion

In this post, I’ve tried to highlight some of the common sources of potential misalignment between the various shareholders of a startup enterprise:  founders, venture capitalists, CEOs, executives and rank-and-file staff.  Hopefully, I’ve demonstrated that things aren’t as simple as they might appear and that just because everyone might own shares, doesn’t mean they have aligned goals and motivations.

If you think I’ve missed any good examples, please let me know.

→ 14 Comments

Posted in management, strategy, Uncategorized, Venture Capital

The Open Source Software Paradox

Posted on May 10, 2011 | 11 Comments

As a marketer, I’m a fan of open source software.   After all, if you can’t dislodge Microsoft from mid-range server operating systems, Microsoft Office from desktop productivity suites, or Oracle from relational databases — and doing so through traditional means is a virtual impossibility —  then blowing up the whole business model isn’t a bad start.  It’s creative and it cuts right to the core of the problem.

But as a business-person I am not.  When you play the role of market spoiler it’s much easier to be famous than rich.  For example, when MySQL was acquired by Sun in 2008 for $1.2B, MySQL was doing only about $65M in annual revenues.  While the revenue multiple on the exit was spectacular, their capture rate was not:  MySQL disrupted literally billions in “big three” (i.e., Oracle, DB2, SQL Server) database revenues.  But if your value proposition is rooted in “almost free relative to leading commercial alternatives,” then you won’t succeed at 50% of their cost; you’ll need to be more like 2-5%.

I refer to open source as both a development model —  i.e., a way of building software — and a business model.  While the former is more well defined than the latter, the typical way to make money in open source is through selling subscriptions or licenses to certified and more-quickly-patched releases as well as selling technical support and/or consulting services to go with them.

While a spectacular exit multiple may occasionally pay off big time for shareholders (e.g., JBoss, MySQL), my theory is that in general it’s very hard to make money with the open source business model.  Red Hat is the obvious exception, and we’ll talk about them in a minute.

The basic paradox of open source is this:

  • The smaller the community the worse the software quality and the more people need certified releases and support.
  • The bigger the community the higher quality the software and the less people need certified releases and support (i.e., the community version will do).

So you can have a large community who doesn’t need to buy from you or a small community who does.

Two other drivers complete the picture:

  • The nature of the software and to what extent it truly requires an almost-daily stream of patches and updates and …
  • The monetization rate which is a function of the commercial market structure.  For example, the lower-level the software (e.g., operating systems) the more the market tends towards natural monopoly as customers want to minimize entropy at the bottom of the stack.  This should drive high pricing/margins on the commercial side of the market, and a parallel opportunity for someone to establish clear leadership on the open source side.

This is why Red Hat does so well when most others end up stagnating in the tens-of-millions of revenues range. The market is huge.  The software is low-level and thus the market “wants” a clear leader (think:  increasing returns) who can provide a hardware-independent, low-cost, supported product as an alternative to the proprietary Unix-es of days past.

Put differently, the bigger the commercial market and the more monopolistic its structure, the better the open source opportunity.  Conversely, the smaller the commercial market and the more fragmented leadership is within it (e.g., enterprise search, document management, and to some extent BI), the worse the open source opportunity.

→ 11 Comments

Posted in Open source, strategy, Uncategorized

If We Can’t Have Repeatable Success, Can We At Least Have Repeatable Failure?

Posted on April 27, 2011 | 5 Comments

I’ve always found business to have a fair amount of accidental, built-in hubris, largely resulting from the strategy formulation process.  I remember one time at Business Objects we had a strategy offsite where, in our infinite wisdom and with a fair bit of groupthink, we came up with the idea for a BI workflow solution, which we dubbed Sundance for the name of the lovely venue at which it was conceived.

I remember coming home from the offsite and having a conversation akin to the following:

Me:  What if Sundance doesn’t work?

Exec:  What do you mean, “doesn’t work?”

Me:  Well, for example, what if nobody wants to buy it?

Exec:  What do you mean, what if nobody wants want to buy it!?  It’s strategic.  We can put incentives in the salesforce compensation plans and bundle it.  Don’t worry, we can sell it.

Me:  I didn’t say what if no one wants to sell it.  I said what if no one wants to buy it.

Exec:  But, it’s strategic.  We decided it at the offsite.  You’re talking crazy Dave.  Come have another beer.

As a marketer by background, I tend to view most everything as an experiment.  That is the nature of marketing.  You never know what’s going to work.  You can try different things.  You can measure them.  You can see what works and what does not.  You can even try to build explanations for why certain things work and certain things don’t.  But you are trained to approach business with humility and with an experimental spirit.

Exec:  Look.  Sundance is not an experiment.  We can’t tell Wall Street it’s an experiement.  We need to tell them it’s the future of the company.

Me:  But what if it isn’t?  What if we’re wrong?  Heck, it’s not a bad idea, but we dreamed it up in two hours on a white board.

The problem is that things fail all the time in business.   Products fail.  Startups fail.  Business models fail.  Heck, Sundance failed.  And the bigger problem is that when we dismiss the possibility of failure in our planning, we dismiss the possibility of learning along with it.

Yes, business — and particularly so in startup-up land — is the quest for finding a repeatable, scaleable model.  (Why?  So you can “just add water” and create an arbitrarily large business — and valuation to go with it.)  But quite often in the hurry for repeatable success, managers fail to design things scientifically so they actually have some degree of repeatability and can thus learn from either success or failure.

Example:  you take a new product and put it in the hands of 8 different salespeople (all of whom are “world-class” as defined by the VP of sales) with 8 different backgrounds in 8 different cities selling to numerous types of different target customers with a variety of different sales pitches.  Consider these scenarios:

  • Everybody sells.  Buy more stock quick.  Anyone can sell this stuff to anybody saying pretty much anything.  (Hint:  this does not happen very often.)
  • Some sell and some don’t.  This is tricky.  Did the folks who sold sell because of their background, their territory, the target customer, their approach, or their salespitch?  Well, we don’t know.  We can look for patterns but we haven’t designed the experiment to make things easy.  The quick assumption is that the folks who sold did everything right and the folks who didn’t did everything wrong, but if you think about it, you can’t assume that’s the case.  Did we have a great salesperson in Chicago pitching the wrong message?  The guy in DC who sold a lot carries a rabbit’s foot — should we dispatch rabbit’s feet instantly to the whole salesforce?  After firing the VP of sales, we learn that “world-class” actually meant “I liked him/her” and can find virtually no additional common traits among the salesforce.  Hum.
  • Nobody sells.  This is hard, too.  Was everybody doing everything wrong?  Unlikely.  Yet, no one came together with the right combination to sell.  But are we sure the lady in Chicago is a bad salesperson?  Can we be sure that the pitch they’re using in DC doesn’t work?  Can we be certain that there is “no market” for the product as the VP of sales is insisting?  What can we learn from such a random experiment?  The answer is nothing.

Thus, my statement:  if we can’t have repeatable success, then can we at least have repeatable failure?

If instead of hiring 8 salespeople, we hired only 3,  put them all in NYC, and called only on the same handful of titles within investment banks using the same sales presentation and demo, could we have learned more?   Yes.

  • If it works, it’s great news, because you know exactly what to go scale.
  • If it doesn’t work, it’s still good news (perhaps for your successor) because you can, with a pretty high degree of certainty, conclude that mix of levers tried will not work.  Or, in the spirit of Thomas Edison, you’ve learned one more way not to make a light bulb.

I’ve picked two extreme cases and there certainly is middle ground in between, but the two key questions are:

  • Are we assuming only successful outcomes in our planning?
  • Are we designing things as an experiment from which we can learn no matter the outcome?

→ 5 Comments

Posted in management, Marketing, strategy

Thoughts on Ben Horowitz’s CEO Psychology Post

Posted on April 4, 2011 | 2 Comments

Last week Ben Horowitz of red-hot VC firm Andreessen Horowitz did an excellent post entitled What’s the Most Difficult CEO Skill? Managing Your Own Pyschology.

My favorite passage (edited):

Even if you know what you are doing, things go wrong. Things go wrong, because building a multi-faceted human organization to compete and win in a dynamic, highly competitive market turns out to be really hard.

If CEOs were graded on a curve, the mean on the test would be 22 out of a 100. This kind of mean can be psychologically challenging for a straight A student, particularly because nobody tells you that the mean is 22.  [...]

Being responsible for everything and getting a 22 on the test starts to weigh on your consciousness.

What then, in the imperfect world that happens to be reality, is the job of the CEO?

  • To get everything perfect?
  • To get what matters right?

I am a huge believer in #2 — the job of the CEO is to get what matters right and, not to put too fine an point on it, the hell with everything else.

I didn’t always feel this way.  When I joined Business Objects in 1995 after spending a decade at two fairly broken companies, I expected that everything would be perfect.  I’d read the S-1 cover to cover.  The company was pristine:  5 consecutive years of profitable 100%+ compound annual growth.  70%+ license revenue contribution.  An amazing IPO lead by Goldman Sachs.  Finally, I thought, I’m going to work at a company that was perfect.

Boy, was I in for a surprise.  Without diving into details, on arriving I discovered that there were zillions of things wrong at Business Objects (e.g., think:  version 4.0).  It was then that I realized it.  Business isn’t about perfection.  It is about getting what matters right. And, boy, was Business Objects good at that.

It’s not about the 22 overall grade.  It’s about getting 100 on the 20% of things that really matter.  This, of course, begs the question “what matters?” which is a question of strategy and one that I’ve already written about here.

The other reason I believe CEOs should focus on getting what matters right (as opposed to everything perfect) is a simple matter of pragmistism.  It is impossible to “focus” on getting everything perfect.  Everything never will be perfect.  CEOs who try to make everything perfect will die trying and probably kill their teams along the way.  In some ways, perfecting everything is a form of avoidance of the really hard question (“what matters?”) as opposed to the easier questions of “what do I know how to do?” and “what’s broken that I can fix?”

It’s easy to find things broken at any company.  The hard part is figuring out what matters and then making those few, strategic things work.  You might get a 22 overall.  But you should get it by scoring 100 on the 20% of the test that matters and 2 on the other 80%.

Doing the inverse is what one friend aptly calls “polishing shoes in the ER.”

→ 2 Comments

Posted in management, strategy

Business Strategy and The Wrong Medicine

Posted on March 11, 2011 | 4 Comments

Let’s say you’re not feeling well, so you visit the Doctor.  You walk into her office and she says, “Hi, it’s great to see you again.  I’m going to start you on 125 mcg of Synthroid.”

You say, “What?  You have even examined me yet!”

“I’m starting you on thyroid hormones because the patient before you had Hashimoto’s disease.”

“But, how do you know what I have?”

This sounds crazy, right?  It would never happen in a Doctor’s office.  But — rather amazingly — it happens every day in business. I call it “rewind/play syndrome” (an increasingly anachronistic metaphor, I now realize) where successful, otherwise-smart business executives repeat strategies that worked in their last engagement, regardless of whether those strategies are appropriate, or even relevant, in their new one.

To make this concrete I’ll give two examples.

My first example is Ingres, an early relational database vendor that for many reasons lost out on the second biggest market opportunity of the last century, losing the RDBMS market to Oracle.  In October, 1990 ASK Computer Systems (the company that defined and dominated MRP, the predecessor category to ERP) acquired Ingres.  In a sense, the company that could have been Oracle was acquired by the company that should have been SAP.  ASK had bet their next-generation product on Ingres, developing it on both the Ingres database and its proprietary application development environment.  In a classic escalation-of-commitment error, when Ingres got into deep trouble, rather than abandoning Ingres and switching horses to Oracle, ASK chose to acquire its technology supplier instead.

Quality, process-focus,  TQM, and Deming worship were the business fashion of the day and, in the manufacturing sector at least, for very good reason.  Since ASK sold almost entirely to manufacturers they knew quality cold.  So when they showed up at Ingres , they did what they knew — implemented a total quality process.  It was a major focus for the first year of the integration. The process itself — just the templates and the forms — took about four 3-inch deep white binders.

The project struck me as impractical from the beginning.  I repeatedly voiced the concern that if we could barely muster the resources to define the process (and maintain that definition) then how in the world could we allocate enough project managers to even have a chance at executing it?

Practical though I was, in my youth I had failed to see the even bigger blunder:  the problem with Ingres wasn’t product quality.  The software was almost universally acknowledged to be superior in both functionality and performance to Oracle.  Yet more and more people bought Oracle anyway.  Why?  Because Ingres was in a landgrab market with high-switching costs and strong increasing returns of market leadership. The further Oracle got ahead the easier it was to beat Ingres.

By 1990, Oracle was already 4x larger than Ingres — the horizontal market was already lost and all the quality process in the world wasn’t going to fix that.  Ingres needed a new strategy — perhaps focused on owning a horizontal or vertical niche — not a TQM overhaul.

Needless to say, the whole thing failed.  In its last quarter as independent company the ASK Group lost $69M on sales of $87M and was subsequently sold for a pittance — $310M, less than 1x revenues — to Computer Associates (CA).

My second example is less dramatic and simply about marketing programs.  At one point in my career I worked for an executive who had been a key part of building Cadence to $1B.  As part of that great success one thing he always remembered and enjoyed was doing some very high-end marketing programs focused on a very small number of people. The concept was to give people experiences they’d never have on their own and that they would remember for a lifetime.  That’s cool.

But to baseline the discussion, note that a typical software company might spend $100 on average to generate a sales lead.  Thus, an expensive marketing program might run $500/lead and a cheap one $25.  The program I’m talking about cost $30,000/lead — 300 times more than the average program and enough, as I pointed out at the time, to buy every participant a Ford Taurus and still have money leftover.

To me, at a gut level it was just crazy — fun, but crazy.  One of my colleagues, however, cracked the code on what was going on by posing the following questions:

  • At Cadence, what percent of total revenues came from your top 10 customers?  While I can’t remember the answer, it was very high — say 70%.
  • At BusinessObjects, what percent of total revenues come from our top ten customers?  Answer, like 5 to 10% — we ran a high-volume, relatively modest deal-size business.

So it wasn’t a matter of whether — in absolute terms — it was just plain crazy to run a program that cost $30K/attendee.  At Cadence, it probably wasn’t — if your top ten customers are generating $700M/year then go ahead and drop the big bucks on the right people at those firms.  But at BusinessObjects, it made no sense.  We didn’t have that kind of business.  Again, see the rewind/play problem.

I can provide a dozen other examples, which I also sometimes refer to as an “FBI guys” problem if you remember the scene from Die Hard where the “professionals” (the FBI guys) show up in black helicopters, take control from the LAPD, and say “this is just like freaking ‘Nam.”  One RPG later, the helicopter is in flames on the ground and LAPD Chief Duane T. Robinson sheepishly says:  “We’re gonna need some more FBI guys, I guess.“

Because I’ve seen this mistake happen so often and committed by so many very smart people, I must admit that I’m rather fascinated by it.  After much thought, I think that business people apply the wrong medicine for several reasons.

  • People like to do what they know.  ASK knew quality, so ASK applied quality to Ingres.
  • People instinctively repeat what made them successful.  You try convincing someone who made $50M executing a given strategy  at his last company that it’s a bad idea at this one.  (Hint:  revise your resume before doing so.)
  • People are often actually hired to repeat what made them successful.  If you look at boards and the search process, they tend to diagnose the problem and then say we want a person who can do X.  Of course, you might think that a new person would still want to make his/her own opinion of what’s indicated, but when you consider the prior point plus the board pressure to lather/rinse/repeat, you can see how it happens.
  • It’s often easier to do what you know and feel busy than step up and face the real problems that are not easy to solve.  Ingres’s real problem was huge — it had blown the market opportunity of a lifetime, needed to give up on general market leadership, and try to gain niche leadership.  That’s a tough pill to swallow.  So it’s easier to blame quality and focus on that.

It’s like saying go bandage the skinned knee when patient has a brain tumor, because at least you know what to do about the knee.  Zig Ziglar, in his oft-told story of processionary caterpillars, calls this confusing activity with accomplishment.

What can executives do to avoid this mistake?

  • Seek first to understand.  If you show up with all the answers, you’re probably just doing what worked last time.
  • Diagnose then prescribe.  Perform a situation assessment of the business and then derive strategy and tactics from the company’s situation.
  • Keep yourself honest.  Beware that rewind/play is a natural human tendency, and ask yourself — deeply and honestly — if you think you’re doing it.
  • Avoid avoidance.  Make a list of your company’s problems, including all the big nasty ones, and then make sure that your strategy isn’t the equivalent of fiddling while Rome burns.  Find the hardest nasty problems, and the biggest best opportunities, and focus your business on them.

Hint:  if you’re blaming “execution” then you’re most probably avoiding bigger, harder strategic issues.

→ 4 Comments

Posted in fail, strategy