Kellblog

How would you like your startup to win deals not only when you win a customer evaluation, but when you tie — and even sometimes when you lose?

That sounds great.  But is it even possible?  Amazingly, yes — but you need have a halo effect working to your advantage.  What is a halo effect?  Per Wikipedia,

The halo effect is a cognitive bias in which an observer’s overall impression of a person, company, brand, or product influences the observer’s feelings and thoughts about that entity’s character or properties

There’s a great, must-read book (The Halo Effect) on the how this and eight other related effects apply in business.  The book is primarily about how the business community makes incorrect attributions about “best practices” in culture, leadership, values, and process that are subsequent to — but were not necessarily drivers of — past performance.

I know two great soundbites that summarize the phenomenon of pseudo-science in business:

• “All great companies have buildings.” Which comes from the (partly discredited) Good To Great that begins with the observation that in their study cohort of top-performing companies that all of them had buildings — and thus that simply looking for commonalities among top-performing companies was not enough; you’d have to look for distinguishing factors between top and average performers.

• “If Marc Benioff carried a rabbit’s foot, would you?”  Which comes from this Kellblog post where I make the point that blindly copying the habits of successful people will not replicate their outcome and, with a little help from Theodore Levitt, that while successful practitioners are intimately familiar with their own beliefs and behaviors, that they are almost definitionally ignorant of which ones helped, hindered, or were irrelevant to their own success.

Now that’s all good stuff and if you stop reading right here, you’ll hopefully avoid falling for pseudo-science in business.  That’s important.  But it misses an even bigger point.

Has your company ever won (or lost) a deal because of:

• Perceived momentum?
• Analyst placement on a quadrant or other market map?
• Perceived market leadership?
• Word of mouth as the “everyone’s using it” or “next thing” choice?
• Perceived hotness?
• Vibe at your events or online?
• A certain feeling or je ne sais quoi that you were more (or less) preferred?
• Perceived vision?

If yes, you’re seeing halo effects at work.

Halo effects are real.  Halo effects are human nature.  Halo effects are cognitive biases that tip the scales in your favor.  So the smart entrepreneur should be thinking:  how do I get one for my company?  (And the smart customer, how can I avoid being over-influenced by them?  See bottom of post.)

In Silicon Valley, a number of factors drive the creation of halo effects around a company.  Some of these are more controllable than others.  But overall, you should be thinking about how you can best combine these factors into an advantage.

• Lineage, typically in the form of previous success at a hot company (e.g., Reid Hoffman of PayPal into LinkedIn, Dave Duffield of PeopleSoft into Workday).  The implication here (and a key part of halo effects) is that past success will lead to future success, as it sometimes does.  This one’s hard to control, but ceteris paribus, co-founding (even somewhat ex post facto) a company with an established entrepreneur will definitely help in many ways, including halo effects.

• Investors, in one of many forms:  (1) VC’s with a strong brand name (e.g., Andreessen Horowitz), (2) specific well known venture capitalists (e.g., Doug Leone), (3) well known individual investors (e.g., Peter Thiel), and to a somewhat lesser extent (4) visible and/or famous angels (e.g., Ashton Kutcher). The implication here is obvious, that the investor’s past success is an indication of your future success.  There’s no doubt that strong investors help build halo effects indirectly through reputation; in cases they can do so directly as well via staff marketing partners designed to promote portfolio companies.

• Investment.  In recent years, simply raising a huge amount of money has been enough to build a significant halo effect around a company, the implication being that “if they can raise that much money, then there’s got to be a pony in there somewhere.” Think Domo’s $690M or Palantir’s $2.1B.   The media loves these “go big or go home” stories and both media and customers seem to overlook the increased risk associated with staggering burn rates, the waste that having too much capital can lead to, the possibility that the investors represent “dumb money,” and the simple fact that “at scale” these businesses are supposed to be profitable.  Nevertheless, if you have the stomach, the story, and the connections to raise a dumbfounding amount of capital, it can definitely build a halo around your company.  For now, at least.

• Valuation.  Even as the age of the unicorn starts to wane, it’s undeniable that in recent years, valuation has been a key tool to generate halos around a company.  In days of yore, valuation was a private matter, but as companies discovered they could generate hype around valuation, they started to disclose it, and thus the unicorn phenomenon was born.  As unicorn status became increasingly de rigeur, things got upside-down and companies started trading bad terms (e.g., multiple liquidation preferences, redemption rights) in order to get $1B+ (unicorn) post-money valuations.  That multiplying the price of a preferred share with superior rights by a share count that includes the number of lesser preferred and common shares is a fallacious way to arrive at a company valuation didn’t matter.  While I think valuation as a hype driver may lose some luster as many unicorns are revealed as horses in party hats (e.g., down-round IPOs), it can still be a useful tool.  Just be careful about what you trade to get it.  Don’t sell $100M worth of preferred with a ratcheted 2 moving to 3x liquidation preference — but what if someone would buy just $5M worth on those terms.  Yes, that’s a total hack, but so is the whole idea of multiplying a preferred share price times the number of common shares.  And it’s far less harmful to the company and the common stock.  Find your own middle ground / peace on this issue.

• Growth and vision.  You’d think that industry watchers would look at a strategy and independently evaluate its merits in terms of driving future growth.  But that’s not how it works.  A key part of halo effects is misattribution of practices and performance.  So if you’ve performed poorly and have an awesome strategy, it will overlooked — and conversely.  Sadly, go-forward strategy is almost always viewed through the lens of past performance, even if that performance were driven by a different strategy or affected positively or negatively by execution issues unrelated to strategy.  A great story isn’t enough if you want to generate a vision halo effect.  You’re going to need to talk about growth numbers to prove it.  (That this leads to a pattern of private companies reporting inflated or misleading numbers is sadly no surprise.)  But don’t show up expecting to wow folks with vision. Ultimately, you’ll need to wow them with growth — which then provokes interest in vision.

• Network.  Some companies do a nice and often quiet job of cultivating friends of the company who are thought leaders in their areas.  Many do this through inviting specific people to invest as angels.  Some do this simply through communications.  For example, one day I received an email update from Vik Singh clearly written for friends of Infer. I wasn’t sure how I got on the list, but found the company interesting and over time I got to know Vik (who is quite impressive) and ended up, well, a friend of Infer.  Some do this through advisory boards, both formal and informal.  For example, I did a little bit of advising for Tableau early on and later discovered a number of folks in my network who’d done the same thing.  The company benefitted by getting broad input on various topics and each of us felt like we were friends of Tableau.  While sort of thing doesn’t generate the same mainstream media buzz as a $1B valuation, it is a smart influencer strategy that can generate fans and buzz among the cognoscenti who, in theory at least, are opinion leaders in their chosen areas.

Before finishing the first part of this post, I need to provide a warning that halo effects are both powerful and addictive.  I seem to have a knack for competing against companies pursuing halo-driven strategies and the pattern I see typically runs like this.

• Company starts getting some hype off good results.
• Company starts saying increasingly aggressive things to build off the hype.
• Analysts and press reward the hype with strong quadrant placements and great stories and blogs.
• Company puts itself under increasing pressure to produce numbers that support the hype.

And then one of three things happens:

1. The company continues delivering strong results and all is good, though the rhetoric and vision gets more unrelated to the business with each cycle.
2. The company stops delivering results and is downgraded from hot-list to shit-list in the minds of the industry.
3. The company cuts the cord with reality and starts inflating results in order to sustain the hype cycle and avoid outcome #2 above.  The vision inflates as aggressively as the numbers.

I have repeatedly had to compete against companies where claims/results were inflated to “prove” the value of bad/ordinary strategies to impress industry analysts to get strong quadrant positions to support broader claims of vision and leadership to drive more sales to inflate to even greater claimed results.  Surprisingly, I think this is usually done more in the name of ego than financial gain, but either way the story ends the same way — in terminations, lawsuits and, in one case, a jail sentence for the CEO.

Look, there are valid halo-driven strategies out there and I encourage you to try and use them to your company’s advantage — just be very careful you don’t end up addicted to halo heroin.  If you find yourself wanting to do almost anything to sustain the hype bubble, then you’ll know you’re addicted and headed for trouble.

The Customer View

Thus far, I’ve written this post entirely from the vendor viewpoint, but wanted to conclude by switching sides and offering customers some advice on how to think about halo effects in choosing vendors.   Customers should:

• Be aware of halo effects.  The first step in dealing with any problem is understanding it exists. While supposedly technical, rational, and left-brained, technology can be as arbitrary as apparel when it comes to fashion.  If you’re evaluating vendors with halos, realize that they exist for a reason and then go understand why.  Are those drivers relevant — e.g., buying HR from Dave Duffield seems a reasonable idea.  Or are they spurious —  e.g., does it really matter that one board member invested in Facebook?  Or are they actually negative — e.g., if the company has raised $300M how crazy is their burn rate, what risk does that put on the business, and how focused will they stay on you as a customer and your problem as a market?

•  Stay focused on your problem.  I encourage anyone buying technology to write down their business problems and high-level technology requirements before reaching out to vendors.  Hyped vendors are skilled at “changing the playing field” and trained to turn their vision into your (new) requirements.  While there certainly are cases where vendors can point out valid new requirements, you should periodically step back and do a sanity check:  are you still focused on your problem or have you been incrementally moved to a different, or greatly expanded one.  Vision is nice, but you won’t be around solve tomorrow’s problems if you can’t solve today’s.

• Understand that industry analysts are often followers, not leaders.  If a vendor is showing you analyst support for their strategy, you need to figure out if the analyst is endorsing the strategy because of the strategy’s merits or because of the vendor’s claimed prior performance.  The latter is the definition of a halo effect and in a world full of private startups where high-quality analysts are in short supply, it’s easy to find “research” that effectively says nothing more than “this vendor is a leader because they say they’re performing really well and/or they’ve raised a lot of money.” That doesn’t tell you anything you didn’t know already and isn’t actually an independent source of information.  They are often simply amplifiers of the hype you’re already hearing.

• Enjoy the sizzle; buy the steak.  Hype king Domo paid Alec Baldwin to make some (pretty pathetic) would-be viral videos and had Billy Beane, Flo Rida, Ludacris, and Marshawn Lynch at their user conference.  As I often say, behind any “marketing genius” is an enormous marketing budget, and that’s all you’re seeing — venture capital being directly converted into hype.  Heck, let them buy you a ticket to the show and have a great time.  Just don’t buy the software because of it — or because of the ability to invest more money in hand-grooming a handful of big-name references.  Look to meet customers like you, who have spent what you want to spend, and see if they’re happy and successful.  Don’t get handled into meeting other customers only at pre-arranged meetings.  Walk the floor and talk to regular people.  Find out how many are there for the show, or because they’re actual successful users of the software.

• Dive into detail on the proposed solution.  Hyped vendors will often try to gloss over solutions and sell you the hype (e.g., “of course we can solve your problem, we’ve got the most logos, Gartner says we’re the leader, there’s an app for that.”)  What you need is a vendor who will listen to your problem, discuss it with you intelligently, and provide realistic estimates on what it takes to solve it.  The more willing they are to do that, the better off you are.  The more they keep talking about the founder’s escape from communism, the pedigree of their investors, their recent press coverage, or the amount of capital they’ve raised, the more likely you are to end up high and dry.  People interested in solving your problem will want to talk about your problem.

• Beware the second-worst outcome:  the backwater.  Because hyped vendors are actually serving Sand Hill Road and/or Wall Street more than their customers, they pitch broad visions and huge markets in order to sustain the halo.  For a customer, that can be disastrous because the vendor may view the customer’s problems as simply another lily pad to jump off on the path to success.  The second-worst outcome is when you buy a solution and then vendor takes your money and invests it in solving other problems.  As a customer, you don’t want to marry your vendor’s fling.  You want to marry their core.  For startups, the pattern is typically over-expansion into too many things, getting in trouble, and then retracting hard back into the core, abandoning customers of the new, broader initiatives.  The second-worst outcome is when you get this alignment wrong and end up in a backwater or formerly-strategic area of your supplier’s strategy.

• Avoid the worst outcome:  no there there.  Once in awhile, there is no “there there” behind some very hyped companies despite great individual investors, great VCs, strategic alliances, and a previously experienced team.  Perhaps the technology vision doesn’t pan out, or the company switches strategies (“pivots”) too often.  Perhaps the company just got too focused on its hype and not on it customers.  But the worst outcome, while somewhat rare, is when a company doesn’t solve its advertised problem. They may have a great story, a sexy demo, and some smart people — but what they lack is a core of satisfied customers solving the problem the company talks about.  In EPM, with due respect and in my humble opinion, Tidemark fell into this category, prior to what it called a “growth investment” and what sure seemed to me like a (fire) sale, to Marlin Equity Partners.  Customers need to watch out for these no-there-there situations and the best way to do that is taking strong dose of caveat emptor with a nose for “if it sounds too good to be true, then it might well possibly be.”