The Fit or Fat Startup

As I sit here at Palantir’s Govcon 5 conference at the lavish Ritz Carlton in Tyson’s Corner (Virgina), I can’t help but think about the recent “fit or fat” startup debate that hit the blogosphere a few weeks back.  The debate started with a post by VC Ben Horowitz of Andreessen Horowitz entitled The Case for the Fat Startup.  Excerpts:

The [Sequoia RIP Good Times] presentation catalyzed a movement. Startups everywhere adopted a lean, low-burn, low-investment model. To this day, companies seeking funding at our venture firm, Andreessen Horowitz, proudly proclaim in their pitch decks that they are raising tiny amounts of capital so they can run lean.

Here is my central argument. There are only two priorities for a startup:  (1) winning the market and (2) not running out of cash.

Running lean is not an end. For that matter, neither is running fat. Both are tactics that you use to win the market and not run out of cash before you do so. By making “running lean” an end, you may lose your opportunity to win the market, either because you fail to fund the R&D necessary to find product/market fit or you let a competitor out-execute you in taking the market. Sometimes running fat is the right thing to do.

The part of his argument with which I agree is the “sometimes.”  The simple fact is that strategy must be a function of situation and there are indeed some situations (e.g., landgrabs) where the run-fat model is required.  By landgrabs, I mean the early days of new, destined-to-be-large markets with sufficient switching costs so as to realistically justify losing lots of money in the quest to establish market leadership.  Examples include Amazon in online retail and PayPal (which raised $194M) in online payments. Remember these strategies do not always end happily:  WebVan consumed  $1.2B in venture capital before it went bankrupt in 2001.  Hence my two key criteria:

• A destined-to-be-large market (WebVan missed here, the market for web-ordered groceries today is still non-existent)
• Sufficient switching costs to justify the years of  major losses (many online retailers who “sold dollars for ninety cents” were surprised to find their customers disappeared when they tried to sell them for $1.05)

When you “go big or go home,” sometimes you go home.  I’d argue that the media biases us by looking primarily at successes, not failures, artificially reducing the perceived risk in such strategies.  It’s a bit like saying inner-city youth can escape the inner city through athletic scholarships.  Yes, it does happen.  And yes those athletes sometimes become rich and famous.  But simply because it sometimes works, you cannot argue it’s a good strategy.

I was going to use Oracle as example because they played the landgrab game superbly in the early days of the RDBMS market.  But I think they only raised $10M or so before their IPO in 1986. (Vent:  I just wasted 30 minutes trying to find a precise answer).  So unlike the go-big VC burners, Oracle largely self-funded its ten-year journey to $50M.  My prior employer, Business Objects, raised a total of less than $5M in VC.

The debate picked up steam when fellow VC Fred Wilson of Union Square Ventures responded with a post entitled Being Fat Is Not Healthy.  Excerpt:

In short, since I started investing in the web in ’93/’94, I have invested in about 100 software-based web companies. And the success rate of fat companies versus lean companies is stark. I have never, not once, been successful with an investment in a company that raised a boatload of money before it found traction and product market fit with its primary product.

Boatload is a subjective term. So is traction. So is product market fit. And so is successful. So let me try to define them in the way that I think about them. A boatload of cash is more than $20mm of invested capital. A boatload of cash is monthly burn rates of tens of millions of dollars. Traction and product market fit are customers or users buying or using your product in droves. It is the realization that you’ve found the sweet spot of the market you were going for. And successful is an investment that pays out multiples of the dollars we invested in it. Getting our money back is not successful in my book. Getting three times our money back is good. More than that is great.

Let me say it again. I have never been involved in a successful software-based web service that raised and spent boatloads of money before it found it’s sweet spot. But it has happened. The Loudcloud story that Ben lived and tells in the All Things D post is proof that it can happen.

You can also win the lottery. The odds aren’t great that you will. But millions of people play it every day. I don’t.

Basically, I agree with Fred, with the sole exception of those Amazon- and PayPal-like landgrabs that really are one-shot opportunities that someone is going to win.  The problem is that entrepreneurs, being rabid and optimistic, assume they are in that 1-in-1000 situation about 95% of the time.

Back to Palantir, I think they’re pretty clearly playing the “fat” strategy.  That’s logical because the founders are from PayPal and are undoubtedly applying some rewind/play logic from those days and should certainly have some survivor bias because — well — it worked last time.   (Try convincing a lottery winner that buying lottery tickets is, on average, a very bad idea.) While they’ve raised $35M to-date, I suspect they’ll be raising another round soon, especially if they are to grow from 250 to 400 employees by December 31st as CEO Alex Karp said this morning.

My issue for Palantir is that I don’t see a landgrab market opportunity which they (see prior points) most certainly do.  The technology looks like a set of nice data visualization and graph analysis tools; kind of a nice suite of graph-centered BI tools for tracking entities, relationships, events, and documents across collections of unstructured and structured data tapped from various repositories.  While the front-ends are sexy, and most likely easier to use than what they’re replacing, if you think using traditional BI tools is tough, I think these tools are harder.  Search meets BI this ain’t.

Visualization companies have had a checkered history in enterprise software, with the most successful being vertical and application specific (e.g., Spotfire), so I think Palantir’s vertical focus on government is a good one.  They seem also to make an effort in finance, but my gut feel is that they’re 90% government.  The company is good at PR, has some creative and interesting management philosophies (e.g., 210 of the 250 employees are supposedly “engineers”), and has a professorial and clearly very intelligent CEO.

Operationally, I think they’d be an excellent partner for Mark Logic because we specialize in back-end heavy lifting and (whether they’d freely admit it or not) everything I saw today strikes me as front-end and/or data aggregation, as opposed to data management, technology.  I know we have some partners in common and I believe some customers may have integrated the systems.

Could Palantir be BusinessObjects for unstructured data?  I don’t think so — the technology seems too specialized and too hard for the average user; it’s clearly made for analysts.  On the other hand, could they be MicroStrategy?  Maybe.

Either way, they’re one of very few enterprise software startups these days playing it fat.  If I’m right, they’ll be raising another round in the next few quarters, probably at a nice valuation, and basically playing Horowitz’s playbook.  On verra.