Category Archives: Silicon Valley

My Thoughts on the SVB Meltdown

(Revised 8:56 am 3/19)

Looks like I picked the wrong week to be off-grid in Argentina.

When I came back on-grid last night, I quickly discovered that the world, or more precisely, my Silicon Valley business world, had basically exploded while I was flyfishing in Patagonia.

A few weeks ago there had been talk of a mass extinction event for startups in 2023.  It was about funding, not banking, and the prediction was for the second half of 2023.  But perhaps it had come early and for a different reason.

Instead of writing yet-another explainer article, I’ll do two things:

  • Provide links to the best explainer articles I’ve found thus far
  • Share some of my own views on the situation, reminding readers that I am go-to-market person and former CEO (and not a finance person or former CFO)

The Best Explainer Posts I’ve Found

My Personal Views on the Situation

I’ll quickly share my personal views on the situation here:

  • Almost every company I work with uses SVB.  They are the default startup bank in Silicon Valley.  Many keep all their cash there because it’s a fairly standard term of an associated venture debt loan.  If depositors lose their funds I believe large numbers of startups could fail, eliminating the thousands of jobs that they provide.  The Alderaan scenario.  I think it’s unlikely, but absolutely must be avoided.
  • Startup death is a natural part of the Silicon Valley ecosystem, the Darwinian process that produces the innovation that drives a large part of our economy.  Startup death is a natural part of the process — but it should result from a bad idea or a unworkable product.  Not from your bank failing.
  • There is a blame game with three primary parties involved:  VCs for provoking the bank run, the Fed for raising rates (which devalued SVB’s long bonds), and SVB for putting themselves in an weak position.  Who you blame seems to say more about you than the situation.  People who like SVB blame the Fed.  People who dislike VCs blame them.
  • Answering the question “what happens to us if rates go up?” seems absolutely core to the operation of a bank.  (Think:  it’s what we do here.)  SVB put themselves into a situation where the liquidity rumors couldn’t be easily dismissed.  Yes, VCs likely provoked the bank run, but SVB put themselves in a place where they couldn’t stop it and bungled communications on top of that.
  • You cannot overstate the interconnectedness around SVB.  I know startups with all their money there.  I know VCs who are unable to provide bridge loans to startups because all their working capital is also at SVB.  I’ve heard of founder/CEOs who have all their personal money there as well, so they are unable to even use their own funds to bail out their companies.  The single worst story I’ve heard is a startup who had all their money in SVB successfully arranged a loan to cover payroll and wired that money to their payroll provider … who then put it in SVB.  Additionally, startups often sell to other startups, so the web is intereconnected not just across investors, but companies and customers.
  • SVB’s depositors must be protected.  I’m not talking about bailing out SVB investors or management.  I’m talking about protecting depositors, thousands of startups, the jobs they provide today, and their potential to become world-leading tech companies  — the next Oracle, Cisco, or Salesforce might be killed off if we don’t.

Personally, while I’m not an expert in banking, I am uncharacteristically optimistic because SVB owns plenty of high-quality assets and, as mentioned above, those assets exceed deposits in value (though that is a function of valuation method as discussed in the Rubinstein article).

They are not sitting atop a pile of incredibly complex, thinly-traded derivatives (e.g., CDOs, CDO swaps).  They are sitting atop a pile of long government bonds.   This is not 2008.  SVB is not Lehman Brothers.  Because of this, I think there is a good chance that someone acquires them this weekend (or soon thereafter), finding opportunity in SVB’s wreckage and ending this industry-wide liquidity crunch.

Let’s hope so, at least.

Kellblog Predictions for 2023

Complete version, see note [1] for details.

Yikes, I’m a few weeks later than usual and now slipping into February, so let’s jump right into our ninth annual predictions post before it’s too late to publish. A quick reminder that I do these for fun and fun alone.  See my FAQ for my terms, disclosures, disclaimers, and the like.

Kellblog 2022 Predictions Review
Let’s start with a review of last year’s predictions which, as it turns out, were pretty good.

1. Covid transitions from pandemic to endemic. Hit.  We can debate the semantics.  Epidemiologists would surely differ.  And the billionaires at Davos still don’t treat it like a cold.  But nevertheless, I think people now generally treat Covid as endemic.

2. Web3 hype peaks. Hit.  I don’t think I’ve ever nailed a prediction harder than this one.  My new#boi weeps for its loss in financial, if not aesthetic, value.

3. Disruptors get disrupted. Hit.  The point here was that just as we become our parents, that Salesforce becomes Oracle, Nvidia becomes Intel, and so on.  This is more the ebb and flow of a natural cycle than a specific prediction — but given Salesforce’s rather dismal year end, I’ll give myself a hit.

4. VC continues to flow. Miss.  Well, while VC funding was down dramatically in 2022 compared to 2021, but remember that 2021 funding was at all all-time high.

The more interesting point is that all this didn’t slow VC fundraising, which hit a record high in 2022.

Going forward, while VCs clearly have dry powder, what’s unclear is their willingness to invest it.  High-quality companies will still be financed, if on less stratospheric terms.  Those delivering average performance may find themselves with water, water everywhere, but not a drop to drink.  Some believe that capital won’t flow again until after an extinction-level event for startups in 2023/2024.

5. The metaverse remains meta. Hit.  Big companies periodically catch self-boredom-itis and attempt to cure it with top-down pivots, dreamed up in corporate offsites with no regard for existing customers and no recollection of the organic, bottom-up processes that helped them become big in the first place.  IBM Watson.  Salesforce Chatter.  Oracle Network Computer.  Informatica Analytic Applications.  BusinessObjects Sundance.  Some companies treat these as publicity stunts, talking a big vision, but not really investing.  Others get confused, believe their own marketing, and bet the ranch.  Meta is in that situation:  customers don’t care,  the market doesn’t look attractive, and key employees are leaving.  Yet on they plow.  A+ commitment to a C+ strategy.

6. PLG momentum builds. Hit.  I think PLG momentum built — and peaked — in 2022.  Former Redpoint VC Tomasz Tunguz pointed out that product-led growth (PLG) firms are less profitable than sales-led growth firms, poking a hole in the “product sells itself” myth, and clouding dreams of liberation from costly S&M departments.  (What drove people to the trial again, anyway?)  PLG is a good strategy for certain categories, but VCs have a tendency, with all good intentions, to ram strategies down the throats of portfolio companies.  As it turns out, PLG is like Nebraska:  “honestly, it’s not for everyone.”

7.  Year of the privacy vault.  Partial. While it’s hard to back this with data, I believe both Okta and Hashicorp are doing well with their secrets vaults, which continues to validate the vault design pattern.  I remain excited about vaults as applied to privacy (for all the reasons I detailed last year) and my friends at Skyflow continued to make great progress with their privacy vault business and the evangelization of it.  What if privacy had an API?  Well, it should.

8.  MSDS is the new MBA.  Partial.  I don’t know how to easily measure this (irony not lost), so the scoring is entirely subjective.  The in-hindsight obvious thing I hadn’t seen coming was the integration of the two — e.g., CMU’s Tepper school offers both an MBA in Business Analytics and an MS in Business Analytics, as do many others.  So the new MBA just might be an MBA in Business Analytics or an MSDS.

9.  Get ready for social impact.  Partial.  I was right about the things that concern younger generations.  I was wrong to the extent that those things now matter somewhat less as the downturn transfers power from employees to employers.  Social change isn’t just about what people believe, it’s about their power to get it.  This is not to stay the new agenda will be completely ignored, but simply that change will come more slowly because the balance of power has shifted.

10.  The rise of causal inference.  Hit.  I continue to believe that causal inference will be to the 2020s what data science was to the 2010s.  Read The Book of Why to learn more.  Or take this causal data science course on Udemy.

Kellblog Predictions for 2023
With that warm up, here are my predictions for 2023.

1. The great pendulum of Silicon Valley swings back.  If you look at Silicon Valley over long periods of time, you see a series of pendulums that swing over decades, all loosely coupled to a great pendulum.  In 2022, that great (fka master) pendulum started to reverse its course and that will continue in 2023.

While Davos, Main Street, and Wall Street may differ on scale and scope, everyone agrees that the economy is turning.  On Sand Hill Road, they’re analyzing softening customer demand.  The interesting part is how this will drive six sub-pendulums in 2023.

  • The valuation pendulum: 10x is the new 20x, flat is the new up. That means a lot of companies need to double their size in order to earn their last-round valuation.  Some have raised enough and/or spent sufficiently little that they can do so on existing cash.  Others are not so fortunateRunway extension is the watchword of the day.
  • The structure pendulum:  it’s back.  One way to maintain a flat headline valuation is to raise money with what’s commonly called structure.  Structure generally means financing terms, such as multiple liquidation preferences or participation (definitions here), that favor new investors over existing investors and the common stockholders in a liquidation.  During boom times, structure falls out of favor.  During slowdowns, structure, and the so-called dirty term sheets that propose it, come back.  Caveat emptor.  Think hard and model multiple scenarios before doing a structured round — a dilutive downround or a clean company sale just might drive more long-term value.
  • The growth vs. profit pendulum:  balance is in, growth at all costs is out.  Formerly backseat metrics like ARR/FTE, free cashflow (FCF) margin, R40 score, and gross dollar retention (GDR) come to the front seat joining net dollar retention (NDR) and ARR growth.  ARR growth still predicts enterprise value (EV) multiples well — but particularly if FCF margins are better than 15%.  That means growth is great — but only if you’re profitable.
  • The founder friendliness pendulum: the invisibility cloak loses some power.  In the 2000s you’d routinely hear VCs whinging about “founder issues” at Buck’s.  But in 2009, with the founding of A16Z,  came a new era of founder friendliness and along with it a founder invisibility cloak (or should I say invincibility cloak) whereby the presumption that the founder should run the company became nearly absolute.  That pendulum will start to swing back in 2023.
  • The employee friendliness pendulum. This is basic Michael Porter, but the new environment has reduced the bargaining power of employees.  We’ll discover that many of those perks and policies that were ostensibly rooted in culture and values were actually rooted in competition for labor.  We’re already hearing, “get back to the office” from Benioff et alia.  Or unlimited PTO — the ultimate perverse benefit — from Microsoft.  More companies will follow.
  • The diligence pendulumFOMO gives way to FOFU.  In the past five years, I’ve never seen deals done faster in Silicon Valley, driven by a competitive market, growth investors with pre-conducted diligence, and a fear of missing out on investments.  As the market cools, deals become less competitive, and stories like FTX emerge, things should return more to normal.

2. The barbarians at the gate are back.  Valuations are down.  Growth headwinds are up.  S&M costs are high.   Stock-based compensation (SBC) is increasingly controversial.  That means activist investors will increasingly be swooping in to shake things up.  And PE giants will increasingly be jumping in to clean things up.  Anaplan and Zendesk were taken private in 2022.  Salesforce is under pressure from two activist investors.  Expect more of this activity to follow in 2023.

While it’s not Henry Kravis at the gate this time, it’s Robert Smith, Orlando Bravo, and Paul Singer.  Management teams should prepare themselves for activist investors and adapt their financial profile to keep valuations high.  While staggered boards and poison pills can stave off hostile takeovers, the best protection against an undesired acquisition is a high stock price.

3. Retain is the new add.  As companies prepare for a potential wave of churn, they put more emphasis on retention than ever before.

Why are companies afraid of churn in 2023?

  • The downturn obviously puts cost pressure on customers.  Must-have items can become nice-to-have overnight.
  • SaaS sprawl.  Per Statista, the average company uses over 100 SaaS apps and for many CFOs that’s too many.
  • SaaS rationalization.  There’s an entire emerging category of vendors (e.g., Cledara, Vendr, Vertice) who work to reduce SaaS spend.  Their mission is to drive your churn.
  • Consumption pricing.  Consumption purists (without ratchets in their contracts) may well find themselves swimming naked as the tide goes out.
  • Bankruptcy.  Companies who sell to SMB may see increased amounts of uncontrollable churn as customers cease operations.
  • Consolidation.  Increased M&A can result in fewer, larger customers with larger discounts and lower costs per unit.

Companies increasingly have internalized the cost of churn.  Namely that:

Cost to backfill churn = CAC ratio * churn ARR

That is, with a CAC ratio of 1.6, it costs $16M to backfill $10M in churn ARR.

While this bodes well for the customer success (CS) discipline, it does not automatically bode well for the customer success department.

Those business-oriented CS teams who thought customer advocacy meant generating customers who advocate for the company will continue to thrive.  But those checklist-oriented CS teams who thought customer advocacy meant internal advocacy on behalf of customers may well find themselves restructured. With new cost pressure, the idea of funding an internal K Street is unattractive compared to redeploying those resources to the underlying engines of customer success, such as product, services, and support.

There are, after all, two sides to being in the spotlight.

4. The Crux becomes strategy book of the year.  Frequent readers already know that Good Strategy, Bad Strategy is my favorite book on corporate strategy.  But my favorite part is how it eviscerates all the garbage that passes for strategy in corporate America.

In 2022, Rumelt published a second book, The Crux, which is more focused on how to build good strategy than on how to avoid bad strategy.  I might have named the books Bad Strategy, Good Strategy and Good Strategy, Bad Strategy, respectively, but I suppose that would have been confusing.

I believe The Crux will become strategy book of the year in 2023 because:

  • It takes a positive approach more than a critical one.  Readers generally prefer that, and I think it’s the one thing that held back Good Strategy, Bad Strategy.
  • It frames strategy around the plan to overcome a critical strategic challenge.  I believe 2023 will provide many companies with clear strategic challenges that need overcoming.  Demand will be strong.
  • He is logical, consistent, and practical in his thinking.  Ruthlessly so.  It’s literally therapeutic to read Rumelt if you’ve spent enough years in the C-suite.
  • Unlike business books that promise a magical answer (i.e., if you could just get <blank> right, then everything else will work), Rumelt offers a magical question:  if you could just figure out the crux of your strategic challenge, then everything else can work.

The last point is not just verbal sleight of hand.  Most business books preach a magical hammer (e.g., positioning, storybranding, category creation) — learn to use this one tool and it will fix all of your problems.  Rumelt does the opposite.  He sets you on a search for the magical nail.  Find that one problem — that central knot or apparent paradox — that, if overcome, will enable your success.

As he said in his first book, “a great deal of strategy work is trying to figure out what is going on.  Not just deciding what to do, but the more fundamental problem of comprehending the situation.”  So true, yet so rarely admitted.

5.  The professionals take over for Musk.  While he’s calmed down a fair bit since I wrote my original draft in December, I nevertheless believe that Elon Musk will hand over the CEO reins of Twitter in 2023.  The announcement of his intentions isn’t exactly news, but the question is will he actually do it?  I think he will, largely because it won’t continue to capture him the attention he needs and because the shareholders of Tesla will basically demand it.

I disclaim that I am not a Musk fanboy and that, in general, I am disappointed by the PayPal mafia, which I once saw as so full of promise.  Perhaps my expectations were too high, but as both the Book of Luke and JFK have said, “to whom much is given, much will be required.”  Particularly, in Silicon Valley, where early success can launch a virtuous cycle of opportunity.

While Silicon Valley is a paragon of innovation, it most certainly is not a paragon of management.  Musk exemplifies this:  from improperly conducted layoffs to alienation of customers to product launch fiascos to total disrespect for product management and communications to CEO code reviews to self-contradictory policy statements to empty promises to dozens of other practices.  Despite the thrill of working directly with the icon and megalomaniac, this simply isn’t sustainable.  The professionals will be tapped to take over in 2023.

6. The bloom comes off the consumption pricing roseConsumption pricing has been a hot topic for the past few years with many boards pressing companies to adopt consumption-based models.  The conventional wisdom was roughly:  if you want Snowflake’s NRR of 160-180%, then you need to adopt their consumption-based model; you can’t get there with per-seat annual SaaS or editions and upsells.

While consumption-based pricing tends to break SaaS metrics and while Snowflake is quick to explain that they are not a SaaS model, there has been significant pressure on enterprise software vendors to include at least a consumption-based component in their pricing.  While this makes sense when passing along cloud-based infrastructure charges that scale with usage, when done in general, they forgot two things:

  • To ask the customers.  Wall Street loves 180% NRR, but what about Main Street?  Do CFOs like when their software bill compounds upwards at an 80% rate?  Methinks not.
  • The tide also ebbs.  During rising tides, users go up, usage goes up, and value delivered presumably also goes up.  So maybe that 180% doesn’t sting as much.  But what about when these drivers go down?  As Buffet said, only when the tide goes out do you see who’s swimming naked.

In 2023, we’ll see there are two types of consumption-based vendors:  those with crafty CROs and those with purists.  The crafties will have already structured ratcheted deals that can only go up year over year.  The purists will not have built in that protection and will see consumption-driven churn as a result.  By the end of 2023, we’ll have many more crafty CROs and a lot fewer purists.

The early returns indicate that while consumption-based companies are seeing bigger hits to NRR, that they are nevertheless driving higher overall growth than their subscription-based counterparts.

Much like my PLG prediction last year, I don’t think consumption-based pricing is dying.  But I do think 2023 will remind everyone — some via a slap in the face — that there are two sides to the consumption-based coin.

7. The rise of unified ops.  The last decade has seen the rise of the “ops” function.  Back when I was young, we didn’t have ops.  If you wanted reporting or analytics, you’d go to finance.  But as functions become more automated, as each VP got their own app, and as CEOs and boards applied more pressure for quality reporting and analytics, each function got their ops person.  Salesops, marketingops, supportops, servicesops, and successops.  Sometimes these consolidated into revops or bizops.  Often, however, they didn’t.

What ensued was depressing.  Siloed ops led to QBRs that resembled tag-team cagefights.  When the CRO and the CMO were fighting, they’d tap in their respective ops heads to continue the brawl.  My CXO versus your CXO.  My ops person versus your ops person.  My numbers versus your numbers.  My model versus your model.

During an interim CMO gig, I worked with the CRO to unify the sales and marketing ops teams into a single revops team.  Even though we were separate organizations both reporting to the CEO, we would have one unified ops team — and we didn’t care who it reported to.  Attend both our staff meetings, but one set of numbers, one model, one forecast.  What that gig ended, the first thing the new CMO did was disband it. Let the cage fights begin again.  It’s human nature.

That story notwithstanding, I think 2023 will see the rise of unified ops.  Why?

  • Cost pressures, and the need to increase efficiency.  One single ops team, driving one set of modeling and reporting is cheaper to operate.
  • CRO consolidation.  As some customer success teams are integrated under the CRO, there will be a natural tendency to integrate salesops and successops.
  • Model wars.  CEOs get tired of having to say, “which model?”  The saleops model?  The FP&A model?   The marketingops model?  Why isn’t there just one?  There should be.
  • Battle fatigue.  Siloed ops isn’t just inefficient, the conflicts it generates are highly visible.  Over time, people get tired.  A great ops leader should be an independent trusted advisor to the business, not a personal pit bull in each CXO’s corner.
  • Resource flexibility.  A single team can move resources dynamically to meet the challenges at hand.
  • Software standardization.  Rationalizing SaaS costs and eliminating stack redundancy is easier when the various ops functions are in a single team.
  • End-to-end funnel analysis.  Breakpoints in the funnel cause problems — e.g., sales doesn’t just want 500 oppties generated this quarter, they want the good ones.  But which are the good ones?  The ones that close.  But which are the good ones for success?  The ones that renew and expand.  How can we generate those?  One team, looking end to end, is in the best position to do this analysis.

For all these reasons, I believe (and hope) that 2023 will see the rise of unified ops.

8.  Data notebooks as the data app platform.  I’ll preface this by saying I’m an angel investor in Hex, who raised a $52M round from A16Z last year, so I’m excited about data notebooks for more than one reason.

While data notebooks are old hat to most data scientists, for business analysts and business users, they are still relatively unknown.  Descended from Jupyter notebooks, today’s data notebooks (e.g., Hex, Notable) generally position as something larger, platforms for collaborative analytics and data science.

When it comes to Jupyter notebooks, this tweet was my introduction to the subject, which got me reading the underlying notebook by Kevin Systrom.


Systrom’s notebook is basically a research paper, built in collaboration, with equations; embedded, executable code; its outputs; configuration management; dependency graphs; and more.  Compare that to the unmanaged spreadsheets you probably use to run your business today.

So the idea of generalizing this to data problems and data users of all types was instantly appealing to me.  I remember when I first met with Barry at Specialty’s, he framed the problem as wrapping models.  As data scientists, we can build models, but we need to wrap them in apps — what we’d now call data apps — so users can use them.  Much as a spreadsheet has a builder and a user (think:  lock down all the cells but a few inputs), a more sophisticated model can and needs to be wrapped as well.  But wrapping a model means effectively building an application, and with that comes a dreaded backlog for building and maintaining those applications.  It was a flashback to enterprise reporting circa 2000 (back when you had the report backlog) and I was instantly hooked.

While I’m not sure I agree with Martin Casado that all SaaS apps will be remade as data apps, I do believe the world is ready for data apps.  I see them, perhaps in a more pedestrian fashion, as these integrated notebooks of code (including not only Python but SQL), no code alternatives, sequencing, models, narrative, metadata, and collaboration — and wrapped and ready for consumption.  That’s why I’m a big believer in data apps and I see data notebooks as the platform for building the first generation of them.  Check out the Hex demo on their home page for a five-minute look.

9.  Meetings somehow survive.  To paraphrase Twain, reports of the death of meetings have been greatly exaggerated.  While I’ll confess to the imprudence of giving Death By Meeting to my boss shortly after its publication, the death of meetings is an entirely different matter.  In January, Shopify announced what appeared to be a total meeting ban, but in reality was a ban on scheduled recurring meetings with three or more people along with a two-week cooling-off period before meetings could be added back to calendars.  Nevertheless, this resulted in the cancellation of 10,000 meetings.

While the move provoked some debate, some backlash, and some discussion of DEI implications, it also provoked some pile-on, often under the fairly offensive slogan, “companies are for builders, not managers.”

The death to meetings crowd makes a number of mistakes in its thinking:

  • That everyone is engaged in individual work, like coding or writing.  How should, e.g., an HR business partner add value by not meeting with people?  Or an BDR manager?
  • That managers somehow do not contribute to building a company.  Great, let’s get 100 developers all reporting to the CEO and see what happens.
  • That all meetings are bad.  There’s a clear baby/bathwater issue here.
  • That online alternatives can replace meetings.  The limitations of email and Slack are well known.  They’re great for some things and rotten for others.  My personal rule:  never try to resolve a hard issue over either.
  • That cadence is unimportant.  I believe that the cadence of regular meetings says a lot about a company — e.g., a weekly vs. a monthly forecast call, or a monthly vs. quarterly sales close.
  • That meetings cannot be improved.  In reality, the goal with meetings, as with any tool, is to use them when appropriate.  The quest is to focus on making them better.  I say quest because to do so is both difficult and endless:  as this article from 1976 demonstrates.

10.  Silicon Valley thrives again in 2024.  While I believe 2023 will be a tough, character-building year for startups, we must remember that this is simply another cycle of creation and destruction in Silicon Valley.  The bad news is that companies will be increasingly faced with difficult, sometimes existential, decisions.  The good news for me (at least) is that demand for gray hair seems to go up when the markets go down.  The good news for everyone is that this is simply a cycle, one from which we shall emerge, and when we do so, the world we emerge into will be more rational and fundamentals-focused.

Until then, stiff upper lip, hunker down, and buckle up.

Forsan et haec olim meminisse iuvabit — Virgil.

# # #

Notes

[1]  I inadvertently published an incomplete version of this post on 2/1/23 around mid-day.  While I instantly removed it from the blog, LinkedIn, and Twitter, I was unable to recall the post sent to email subscribers.  Please accept my apologies for this mistake.  While there are a few tricks one can use to avoid such problems (e.g., publish later, don’t create in the WordPress editor), I was on approximately draft 67 of this post, meaning that 66 times I correctly hit “save draft,” but alas once hit “publish” and off it went.

Appearance on the AI and the Future of Work Podcast

Just a quick post to highlight my recent appearance on the AI and the Future of Work podcast hosted by my friend Dan Turchin.

I joined Dan to discuss my work-in-process 2023 predictions post (which I really need to get finished in the next week).  We start out by reviewing a few of my 2022 predictions, where Dan takes a somewhat European angle in his questioning given my work with Balderton Capital.  After that, based on the sneak preview of my 2023 predictions that I gave to Dan, he asks some questions about what I see coming in 2023.

It’s a long episode.  Dan asks some great questions, and I give some rambling answers, so if you’re listening on the treadmill make sure you pace yourself.  You’ll be burning a few more calories than usual.

You can find the episode on Spotify and Apple podcasts.  Thanks again to Dan for having me and I hope you enjoy the episode.

Fighting Envelopment Strategies: What To Do When A Larger Company Tries to Absorb Your Category

If you live in the country and see someone out walking a smaller dog, once in a while it will be dressed like this:

Does your startup need a coyote vest?

That’s called a coyote vest and it’s pet body armor designed to prevent Bruiser from being taken by a coyote and/or hawk.  I think about coyote vests whenever I think about larger vendors running envelopment strategies against smaller vendors.

A Review of Envelopment Strategies
Envelopment strategies are common, and often winning, strategies in enterprise software.  Two classic examples from the days of yore:

I’ve written before about envelopment strategies, then using SuccessFactors and Marketo as examples.  I’ve executed envelopment strategies, too.  At BusinessObjects, we pioneered the category for query & reporting (Q&R) tools, and then ran an envelopment strategy that broadened and transformed our category into business intelligence suites.  We did that by building OLAP into our Q&R tool, and then spending $1B to acquire Crystal Decisions in enterprise reporting.

More recent examples include:

  • Qualtrics, who evolved from a product-centric survey software positioning to a solutions-centric experience management (XM) positioning, and defined a new category the Play Bigger way in the process [3].
  • Alation, who pioneered the data catalog as an application for data search & discovery and then transformed it into an overall data intelligence platform for data search & discovery, data governance, cloud data migration, and data privacy.

Alation transformed the data catalog from its original search & discovery use-case to a broader, data intelligence platform.

In short, envelopment strategies work — to the point where they’re basically the standard play in enterprise software:  pioneer a category, win it [4], up-level it by defining a broader problem, define what’s in and what’s out when it comes to solving that broader problem [5], and then deliver against that definition.

But that’s just our warm-up for today, where our question is not whether envelopment strategies are effective (answer, yes) but instead:  what should I do when a competitor is trying to envelop me?

Combatting Envelopment Strategies
Deciding your response to an envelopment strategy requires you to determine where your category fits into the larger vendor’s broader vision.

The key question:  is your space one of the top three (or so) strategic components in the larger vendor’s broader vision?  If it is, you face a very different situation from when it is not.

For example, back in the early days of CRM, sales, marketing, and customer service were all defined as in the space.  But professional services was out.

The original definition of CRM left room beyond sales, marketing, and service (as well as plenty of room within each)

When your company is not within one of those strategic components, life is fairly easy.  You will likely be able to partner with the larger vendor because while vision overlap may exist, reality overlap does not — and the sales force knows that.  For example, early CRM vendors did not offer a professional services automation (PSA) tool and their sellers were typically happy to connect customers to a good PSA offered by a friendly partner.

While such partnerships sow the seeds of downstream conflict because the larger vendor usually expands its scope over time, that is a high-class problem.  You can build a substantial company in the period between the larger vendor’s first entry and when they eventually get their act together.  That often takes multiple, failed, organic attempts — executed across years — followed by a change in course and a major acquistion.  Oracle failed repeatedly at in-house-developed applications for about 15 years before eventually changing course to acquire PeopleSoft, Siebel, and others.  Salesforce eyed Yammer around 2010, then built Chatter to an only modest reception, and about 10 years later acquired Slack to provide best-of-breed collaboration.

But it’s not usually as simple as in or out.  Because these boxes tend to be quite broad, there is usually room for specialization.  For example, for many years customer service largely meant case management to Salesforce — omitting B2C customer service (e.g., high-volume case deflection portals) or field service (e.g., rolling trucks).  ServiceMax, RightNow, and Click all partnered succesfully with Salesforce in these areas before Oracle acquired RightNow (early in the game) and Salesforce later acquired Click after nearly a decade of partnership.

Consider some popular specialty areas with sales today, including revenue management (e.g., Clari, BoostUp), conversation intelligence (e.g., Gong, Jiminny) and sales enablement (e.g., Highspot, Seismic) [6].  And there are many more.

Sometimes, the situation is more subtle, where the issue is not room due to specialization, but room due to lack of commitment.  In these cases, the larger vendor “cares, but not that much” about a box.  The vendor may want to cover a large number of boxes, each with a different commitment level that is usually known with the organization [7], but never expressly communicated:

  • High.  We must succeed in this space.
  • Medium.  We care, but not that much.
  • Low.  We really don’t care and just want to “check the box.”

If you skim the larger vendor’s marketing, it will be difficult to discern the level of commitment associated with any given space.  But, if you spend more time, looking for rich content, deep white papers, and numerous customer reference stories, you will likely develop a sense for whether the marketing is simply veneer covering a low-commitment box as opposed to the hardwood of a core one.  Either way, the sales force will know.  Partners will know.  Most employees will know [7].

For example, Oracle had its own BI tool, Discoverer, the entire time BusinessObjects grew from zero to IPO, serving largely Oracle customers, in many cases partnering with the Oracle field [8].  In strategy circles, Oracle was executing a “weak substitutes” strategy, treating the space opportunistically, hoping to get extra revenues from indifferent customers, but understanding their offering was not fit to win in a best-of-breed evaluation.

Summary of Strategic Responses to Envelopment Strategies
With that backdrop, let’s summarize the options for how you can respond when someone tries to envelop you.

  • Sell.  The key here is timing.  If a bigger vendor approaches you early in your lifetime, you might think “too early for me.”  But, for them, it’s a clear sign that they are tracking the space and doing a make / buy / partner assessment.  If you rebuff the offer, you might get a second chance, but it will likely be years later, after they try building it themselves or acquiring another company and failing.  Remember, when selling to a strategic, it’s about them, not you [9]. Examples:  Aptrinsic selling to Gainsight, Chorus selling to Zoominfo, though later in its lifecycle.
  • Specialize.  Get so strong in your space that buying another vendor wouldn’t really solve the larger vendor’s problem, thus they decide to build or partner in the space.  If you execute well and you’re really focused, you can beat their in-house development efforts and stay a leader despite the larger vendor’s efforts.  If you also have great access to capital so you can grow fast, you can also build a substantial company while the larger vendor fumbles around.  Your strength and anticipated response can shape their “in/out” definition of the category.  Examples:  Gong, Clari, Amplitude [10].
  • Segment.  Pick a size-based, functional, or vertical segment of the market and go deep.  Think:  we’re the best CRM vendor for SMB/MM (Hubspot), we’re the best application for the customer service function (Zendesk), or we’re the best marketing personalization vendor for retailers (Bluecore).  This strategy can work very well to provide differentiation from the would-be enveloper and build a moat to protect your from their attack.  Think:  “the megavendor may be in bigger in the overall market, but nobody knows and cares about you like we do.” [10]
  • Counter.  Envelop back.  If someone tries to envelop you, well, two can play that game — and you can envelop right back.  This works best when you’re similar in size to the would-be enveloper.  Examples:  Back in the day, BusinessObjects and Cognos each tried to envelop each other.  After BusinessObjects bested Cognos in the BI suites evolution, Cognos countered by trying to unite BI suites with planning software to create enterprise performance management [11].  Today, in a similar clash, Alation and Collibra are trying to envelop each other in data intelligence platforms, the former starting from its leadership position in data catalogs and latter from its strong position in data governance.  I believe Alation has the better strategic position in that battle and that seems to be proving out in the market [12] — though I am by no means a disinterested observer [13].
  • Suffer.  Finally, you can pretend that envelopment isn’t happening around you — an all too popular strategy, that rarely results in a good outcome.  As Mark Twain said, “denial ain’t just a river in Egypt.”  Ignoring category envelopment is a fast path to becoming a question in Trivial Pursuit Enterprise Software Edition.  Example:  name the enterprise reporting vendor who, in the early 2000s, had a superior product, but nevetheless lost to Crystal?  Answer:  Actuate.  While it’s fashionable to say, perhaps over a nice glass of Michter’s 20 year in Davos, that building a company is about ignoring the competition and following your true North Star, that has nothing to do with the real world of strategy which is all about rising to strategic challenges, which often arise from competition.

A good strategy honestly acknowledges the challenges being faced and provides an approach to overcoming them. — Richard Rummelt

# # #

Notes

[1] Hence the original, and fairly long-lasting, definition of CRM as sales, marketing, and service.

[2] That Siebel would shortly thereafter miss the cloud transformation and be displaced by Salesforce is a story for another day.  Per an old friend who used to work there:  “I decided to leave Siebel the day I heard the quite powerful VP of Product say we were going to beat Salesforce by being more Siebel than we’ve ever been.”

[3] Effectively doing two transformations:  (a) from survey software to customer experiencement management, (b) from customer experience management (application) to overall experience management platform — for customer, employee, product, and brand experience management.

[4] Don’t forget this important step!  You can be too busy thinking about the next thing to remember to win the category you pioneered.

[5] The hardest part of the exercise in my opinion.  Where do you need to make, buy, or partner?  What really needs to be integrated in versus what should be connected externally and/or built upon.  This is an exercise that intersects customer centricity with core competencies.

[6] I’m happy to say I joined the board of Jiminny in 2022.

[7] Sadly, know usually means tacit knowledge within the company and its close ecosystem.  Companies seem to feel a need to communicate as if they are all-in in every space in which they play.  This damages corporate credibility, but there is no obvious alternative.  Think:  “we sell a great thing 1, 2, and 3 and a just-OK thing 4 and 5.  People figure it out anyway, but it’s hard to say in a marketing collateral or sales training.  Plus, sometimes, senior management think it’s also a great thing 4 and 5, and few are willing to tell the Emperor that they’re wearing no clothes.

[8] Knowing that a $3M data warehouse Oracle database deal might ride on the success of a demo built in a $50K BI tool, and knowing that Oracle had only a weak commitment and a meh BI product, a seller might willingly trade away the $50K of BI tool revenue to increase the odds of winning the $3M database deal.

[9] Making a product acquisition, especially a strategic one, at a larger vendor requires much more than it being a good idea.  It’s more like stars aligning.  Larger vendors often track spaces and key vendors within them for years before making an acquisition.  Triggers for actually making an acquisition could be a competitor acquisition (e.g., Oracle buying Endeca in response to HP acquiring Autonomy), the loss of a major customer, acknowledgement of failure in a new product initiative, a change in board sentiment, or a drop in a company’s stock price such that it become acquireable.  Example:  we had discussions with Acta several times, over a period of years, before eventually acquiring them at BusinessObjects.

[10] Specialize and segment are both the coyote vest strategy — get so strong in a space that it’s unenvelope-able (or at least, not worth enveloping) from the larger vendor’s POV.

[11] Via the acquistion of Adaytum.  And yes, the original definition of EPM was the unification of BI and planning.  This was an analyst-led shotgun wedding that Cognos embraced and one that never really made sense to customers.  While BusinessObjects later countered by acquiring SRC, BI and planning never really came together.  You could put them under one proverbial roof, but they never became one category.  The two categories later diverged and EPM was redefined as the unification of financial planning and consolidation software (another analyst-led shotgun wedding that also later largely fell apart).

[12]  If you want to provide a general-purpose data access platform designed to help a wide range of users find, understand, and trust data, are you better off starting from a data access point of view (POV) or a data governance one?  Methinks access, as it’s fundamentally a “play offense with data” POV whereas data governance is fundamentally a “play defense with data” POV.  I think customers want to buy the former (offense, subject to proper defense as a constraint) and it’s easier to adapt an access POV to governance than the converse. Growing up around dusty glossaries and policies isn’t a great way to get spiritually in tune with end-user needs, collaboration, access, and a data democratization POV.  IMHO.

[13] I have a long history with Alation as an angel investor, advisor, former board member, interim gig employee, and consultant.

The More Cons than Pros of the Backdoor Search

You’ve decided you need to replace one of your executives.  Hopefully, the executive already knows things aren’t going great and that you’ve already had several conversations about performance.  Hopefully, you’ve also already had several conversations with the board and they either are pushing for, or at least generally agree with, your decision.

So the question is how to do you execute?  You have two primary options:

  • Terminate and start search.  Arguably, the normal order of operations.
  • Start search and then terminate.  This is commonly known as a backdoor search, I guess because you’re sneaking out the back door to interview candidates.  More formally, it’s known as a confidential search.

Yes, there are a lot of sub-cases.  “Search” can mean anything from networking with replacement CXOs referred by your network up to writing a $100K+ check to Daversa, True, and the like.  “Terminate” can mean anything from walking the CXO out the door with a security escort to quietly making an agreement to separate in 60 days.

As someone who’s recruited candiates, been recruited as a candidate, and even once hired via a backdoor search, let me say that I don’t like them.  Why?

  • They make a bad impression on candidates.  Think:  so, this company is shooting their CMO and that person doesn’t even know it yet?  (Sure, I’d love to work for them.)
  • They tie the recruiter’s hands behind their back.  Think:  I have this great opportunity with a high-growth data workbench company — but I can’t tell you who it is.  (Call me when you can.)
  • They erode trust in the company culture.  The first rule of confidential search is there are no confidential searches.  Eventually, you get busted; the question is when, not if.  And when you do, it’s invariably a bad look for everyone involved.
  • They are super top-down.  Peers and employees are typically excluded from the process, so you neither build consensus around the final candidate nor let them meet their team.
  • You bypass your normal quality assurance (QA) process.  By involving fewer people you disregard a process that, among other things, helps vet the quality of candidates.  If the candidate turns out a mishire you are going to feel awfully alone.
  • If you somehow manage to pull one off, the candidate gets off to a rough start, typically never having had met with anyone on their team.

That said, the advantages of confidential searches are generally seen as:

  • No vacant seat.  There’s no awkward period where the CXO’s seat is empty and/or temporarily filled by one of their direct reports.
  • Short transition period.  You elminate the possibility of an extended period of ambiguity for the CXO’s team.  Colloquially, you rip off the band-aid.
  • One transition, not two.  Some positions (e.g., CFO, CMO) have active fractional (or rent-a-CXO) markets.  If you terminate first, hire an interim replacement, and then search for a permanent replacement, you end up putting the team through two transitions.

I’d argue that for conflict-averse CEOs, there’s one bad “advantage” as well — they get to put off an unpleasant conversation until it’s effectively irreversible.  Such avoidance is unhealthy, but I nevertheless believe it’s a key reason why some CEOs do backdoor searches.

All things considered, I remain generally against backdoor searches because the cost of breaking trust is too high.  Lady Gaga puts it well:

“Trust is like a mirror, you can fix it if it’s broken, but you can still see the crack in that mother f*cker’s reflection.”

So what can you do instead of a backdoor search?  You have three options:

  1. Run the standard play, appointing an interim from the CXO’s directs or doing it yourself.  (If you have the background, it’s relatively easy and sometimes it’s even better when you don’t —  because it helps you learn the discipline.  I’ve run sales for 18 months across two startups in this mode and I learned a ton.)
  2. Run with an interim.  In markets where you can do this, it’s often a great solution.  Turns out, interim CXOs are typically not only good at the job, but they’re also good at being interim.  Another option I like:  try-and-buy.  Hire an interim, but slow starting your search.  This de-risks the hire for both sides if you end up hiring the interim as permanent.  (Beware onerous fees that interim agencies will charge you and negotiate them up front.)
  3. Agree to a future separation.  This is risky, but a play that I think best follows the golden rule is to tell the CXO the following:  “you go look for a job, and I’ll go look for a new CXO.”  A lot can go wrong (e.g., undermining, hasty departure, mind changing) and you can’t really nail it all down legally (I’ve tried several times), so you can only do this option with someone you really trust.  But it allows you to treat the outgoing CXO with respect and enables them to not have to ask you for a reference (as they’re still working for you).  You’re basically starting a search that is “quiet” (i.e., unannounced internally), but not backdoor because the CXO knows it’s happening.

Hat tip to Lance Walter for prompting me to write on this topic.