startups

Inversion: The surprising secret of winning in business.

jitha

2013 was a big year for me. But at the end of it, I was left wondering if it had been a hopeless waste of time.

I had been thinking about quitting my job and starting up, for a while. But I took the plunge in Jan 2013.

Got two solid co-founders, an interesting SaaS idea, and a few months of runway. Thus began the entrepreneurial dream.

Fast forward 10 months.

The product was ready, customers were mildly interested. But it was clear it wouldn’t work.

It was a structural effort-value mismatch. A long sales process and too much integration effort, but not a must-have product.

We tried many things but the writing was on the wall. The revenue would never justify the effort.

And here’s the other thing: we were running out of runway (personal savings). We couldn’t continue paying salaries for much longer.

So that was it then – end of the entrepreneurial dream? 12 squandered months, and then sanity prevails?

Time to go back to a regular salaried job?

Before we talk about what happened next, let’s take a short break and talk about… tennis.

The Amateur Game of Tennis.

One of my favorite David Foster Wallace (he of “This is water” fame) lines is from his essay, Derivative Sport in Tornado Alley:

I couldn’t begin to tell you how many tournament matches I won between the ages of twelve and fifteen against bigger, faster, more coordinated, and better-coached opponents simply by hitting balls unimaginatively back down the middle of the court in schizophrenic gales, letting the other kid play with more verve and panache, waiting for enough of his ambitious balls aimed near the lines to curve or slide via wind outside the green court and white stripe into the raw red territory that won me yet another ugly point.

It wasn’t pretty or fun to watch, and even with the Illinois wind I never could have won whole matches this way had the opponent not eventually had his small nervous breakdown, buckling under the obvious injustice of losing to a shallow-chested “pusher” because of the shitty rural courts and rotten wind that rewarded cautious automatism instead of verve and panache.

In professional tennis, Federer wins by hitting the ball accurately to the far corner. But in amateur tennis, you win simply by not hitting the ball out of bounds.

In fact, in amateur tennis, you don’t win matches. You avoid losing them.

It’s boring, yes. But that’s a feature, not a bug.

And it’s surprising how far you can go, by just following this dictum: Keep it simple.

Ankesh Kothari has another great example, in How to participate in the Olympics without any skill:

Elizabeth Swaney participated in the 2018 Winter Olympics in freestyle skiing. She skied straight without performing any tricks that the sport is known for. And she came in dead last. That’s not the surprising part however.

The surprising part is that she had never won any skiing competition in her whole life, and yet she qualified for the Olympics!

How can one qualify for the Olympics without winning any competition at all?

Swaney did one thing better than anyone else. She showed up. She attended all of the qualifying events in the two years before the Olympics. All of them. She didn’t miss a single one. And in all of the events, she skied straight, never falling down. Many of the contestants would do tricks and swirls and jumps in the air to show their skills. And many of them would inadvertently fall. Swaney never fell once.

And that’s how, she outperformed her more skilled colleagues and got enough points to qualify for the Olympics without winning any competition. Because she never failed.

Now, this is not just an idea from sport. You’ve heard of it before…

Inversion: A surprisingly powerful idea.

The power of Inversion

One of Charlie Munger’s pet mental models is Inversion.

It’s a simple but profound idea.

To win, don’t lose.

Morgan Housel has a great paragraph about how Warren Buffett did exactly this:

There are over 2,000 books picking apart how Warren Buffett built his fortune. But none are called “This Guy Has Been Investing Consistently for Three-Quarters of a Century.”

But we know that’s the key to the majority of his success; it’s just hard to wrap your head around that math because it’s not intuitive. There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called “Shut Up And Wait.”

If you take away Buffett’s top 10 bets, he would look quite mediocre. The two secrets of his success are:

  1. Not striking out. He stays within his circle of competence, so he never risks complete ruin.
  2. He’s been doing this consistently for 75 years

That’s what winning is mostly: not losing.

Over a 40 year career, as long as you don’t shoot yourself in the foot, you’ll win.

In a power law world, optimize for staying in the game.

In a power law world, effort ≠ outcomes.

Luck plays a big role. One big break can make all the difference.

In such situations, it’s important to stay in the game.

It’s like surfing – you need to stay in the water. You need to be patient, and lie in wait for the big wave.

It’s hot out there. You might be ready to leave in an hour. “The water’s quiet today, let’s go grab a beer.”

And just as you step out, there comes a monster wave!

That’s why…

Do what you can to stay out there.

Don’t burn out. Keep adequate runway.

Keep experimenting and trying different things – you don’t know what will click.

But don’t take existential risks. Take small risks that you can manage.

Nowhere is this truer than in the case of startups. 90% of startups fail. A tiny proportion reach steady profitability. And a much tinier proportion create life-changing wealth.

So… I’m going to give you some strange advice.

Don’t be like Elon Musk.

Elon Musk is the archetypal visionary entrepreneur. Ignore naysayers, stick to your vision, and win big.

But again, don’t be like Elon Musk!

He bet all his wealth throwing one last Hail Mary. And he did that several times. Funding one last launch for SpaceX after all the previous ones had failed. Saving Tesla from the jaws of bankruptcy.

In this universe, it all worked out and he’s the world’s richest man. But it so easily might not have worked, and he would have flamed out.

Pablo Escobar's Brother Says Elon Musk Stole His Flamethrower Idea, Wants $100 Million Payment
Instead, he’s selling flamethrowers.

So don’t be like Elon Musk. Be like Phil Knight instead.

In 1966, his company, Blue Ribbon Sports, was running out of cash to expand. His bank refused to give him working capital. And the only other bank in town had already rejected his application!

So he went back to work as a CPA at PwC. Plowed most of his salary back into the business to make it work.

He did this for 5 years.

First, the company stayed barely alive. But soon, some of its experiments started working.

The company still exists today, btw. You may know of it as Nike.

Quick interlude: If you like what you’re reading, don’t forget to subscribe! Many say Sunday Reads is the best email they receive all week.

Coming back to my story.

Where did we leave off?

Oh yes, me staring at a blank wall and a vanishing bank balance, wondering if this was it.

But then I asked myself, “Did you really expect that your first idea would be a hit?”

Of course not. So, the answer was clear: Do whatever we can to keep going.

So I went back to my consulting firm. Luckily I had enough trust in the system to work part-time (8-16 hours a week) on specific projects.

I put all my income back into the business. My co-founder did the same.

We pivoted the company and hired developers to build a consumer-facing app instead.

And the payoff came soon after.

We launched the product within 5 months. And within one month of launch, we had 18K users. We were onto something!

I’ve written before about what happened next. How we went from ~20K users to 200K users, with *zero* marketing spend.

But it all started with that one move. Flipping from default dead to default alive.

What did I learn?

At the highest level, this is what I learned: To win, don’t lose.

To win, don't lose. Invert.

In life and business, winning is not as much about spectacular victory, as it is about *not losing*.

Do the small things right and don’t die, and over a 40 year career, you’ll win big.

More specifically, I came away with three lessons:

#1. Optimize to stay in the game, in a power law world.

When luck is a big factor, you need to have as many “at-bats” as possible. So prioritize staying alive.

To win big, you need to take risks. You need to experiment. But never take the risk of ruin, no matter how small.

Don’t play Russian roulette, even if the gun has a hundred slots and just one bullet.

Take risks, but also protect yourself. When in doubt, remember the barbell strategy (I also wrote about the barbell strategy for crypto investing here).

#2. When you see an opening, swing hard!

When the big wave does come, that’s the time for action!

In late 2014, we saw an opportunity to partner with PAYBACK (India’s largest loyalty player at the time, with ~50M users). We went all-out to get the deal (including a lot of negotiation prep: Never Split the Difference is a great resource. My summary here).

We also guerrilla-ed our way into a free video endorsement from a movie celebrity. But that’s a story for another day.

#3. Keep it simple.

When you’re about to try something new in your business, ask yourself:

  • Is this like curving the ball into the top corner? What if I miss? Is it game over?
  • Or is there something simpler I can do, to keep the ball in play?

When in doubt, keep the degree of difficulty low. Make it easy.

Stack a few easy steps on top of each other, and voila! You have a 10/10 triple somersault.

PS. There are many great examples of successful entrepreneurs who kept their previous jobs when they started up.

The most fascinating is Herb Kelleher, who kept his private law practice for 14 years after starting Southwest Airlines.

Read that again – 14 years, running a frigging airline as a side hustle!

More in my twitter thread here.

The Grand Unified Theory of Management

jitha 2 Comments
Theory of Constraints

The Theory of Constraints is the closest we have to a Grand Unified Theory of Management. It cuts straight to the problems that matter, be it in business or your personal life.

It’s a simple statement:

Any system with a goal has one limit. Worrying about anything other than that limit is a waste of resources.

Eli Goldratt propounded it in his 1984 book, The Goal, as a series of observations on assembly line manufacturing. But it applies to nearly everything.

Why is it so powerful?

Three Easy Pieces

The Theory of Constraints is a set of three simple statements, in a tightly connected chain of logic:

#1: Every system has one bottleneck tighter than all the others.

A limiting factor more limiting than the others. A weakest link in the chain.

#2: The performance of the system as a whole is limited by the output of this one bottleneck.

If you increase the throughput of this one bottleneck, the throughput of the entire system increases.

#3: Therefore, the only way to improve the performance of the system is to improve the output at the bottleneck.

What does this mean? It means that any improvement not at the constraint is an illusion. For the same reason there’s no way to strengthen a chain without strengthening its weakest link.

You can do your best to increase capacity of all the non-bottleneck steps. Or, when you realize there’s actually excess capacity at all these steps (by definition – when the bottleneck is at full capacity, all other steps have excess capacity) you can do your best to fill them up.

But it will make no damn difference at all.

Stated even more simply, this is the Theory of Constraints:

Any system with a goal has one limit. Worrying about anything other than that limit is a waste of resources.

Theory of constraints - Summary

So, solving any problem is a series of three simple (but not easy) steps:

  • Step 1: Identify the current most limiting factor.
  • Step 2: Identify the most obvious way to improve this limit, and implement it.
  • Step 3: Go back to Step 1. Because there will be a new limiting factor. There is always one limiting factor.

Why do we not do this totally obvious thing?

When your business struggles to deliver its output, or you struggle to lose weight despite all your attempts – it’s usually because of one of three reasons:

Solving the wrong limit:

You’re hiring more capacity in the sales team to get more deals. But the constraint is really in the delivery team.

In the weight loss domain: you’re cutting calories, when the issue is that you’re stressed and cortisol is wrecking havoc with your body.

Solving yesterday’s limit:

This is a little like army generals who fight the last war.

Yes, sales was the constraint 6 months ago, and so you decided to hire 3 people. But it’s no longer the limiting factor after you got one person.

Once a limit is removed, doing more of it just won’t help.

As Taylor Pearson says in his article, “what got you here won’t get you there”. What gets a business off the ground is not what keeps it in the air.

Not realizing when the limiting factor has changed:

By focusing the entire team on sales proposals, guess what, delivery is suffering. So now inflow of business is no longer the limit. It’s actually servicing that business.

But you don’t realize it until 3 months from now, when the clients don’t renew.

There’s a meta-reason too.

There’s a meta-reason too, which causes us to make these errors.

Seeing something that’s hard to solve, we decide to solve something easier.

A great example of this is the classic Bike-Shed Effect, or the law of triviality.

From Wikipedia:

Parkinson provides the example of a fictional committee whose job was to approve the plans for a nuclear power plant spending the majority of its time on discussions about relatively minor but easy-to-grasp issues, such as what materials to use for the staff bike shed, while neglecting the proposed design of the plant itself, which is far more important and a far more difficult and complex task.

The example is fictional. But we’ve all seen it.

Like spending a company leadership meeting discussing how to increase profits by reducing employee per diems. Instead of the real strategic choices to navigate a recession. (I’ve seen this).

Sometimes it’s almost too banal.

We start the meeting saying, “there are 4 topics to discuss today. Let’s do the easiest 3 topics quickly, and then devote some time to the thorny one”. Well, guess what, you spend 25 min on the easy topics (Parkinson’s Principle – work expands to fill the time you give to it). And then the next 5 min scheduling a follow-up to discuss the thorny issue.

OK, I’m being a little unfair. Because this stuff is HARD. We want to make progress. It boosts our self-esteem, among other things. And ticking a box “DONE” feels like progress. Even when it isn’t.

At other times, this mistake is almost invisible. It looks like more legitimate progress.

I used to run a consumer internet startup in India. An app called Smart Saver, where people could upload receipts from their grocery purchases, to get cashbacks.

During our initial days, my team and I brainstormed and built a lot of features to keep people on the app. Including both mechanisms (do xyz tasks to earn more cashback) and content (giving cashbacks for brands we hadn’t yet partnered with), etc.

But any progress on this was an illusion.

As a small app with 20K users at that time, the main constraint wasn’t retaining those 20K users. It was a constraint, yes. But it wasn’t the critical one.

The critical constraint was going from 20K → 200K users.

Any cool features we were building would solve only the less-important constraint.

But it was actually worse than that. Onboarding funnels themselves are leaky. So, any down-funnel feature would be seen only by a proportion of the users who installed the app. The rest would have dropped out of the funnel at the top! So, our cool and nifty features would be seen only by a small proportion of the miniscule 20K users we had!

I wrote about this in Drunkards and Streetlights:

We brainstorm and build cool new features for our apps, when the onboarding funnel itself is leaky. Andrew Chen calls this the next feature fallacy….

for most of a startup’s life (after Product/market fit, but before it becomes a Facebook), the top of the funnel (i.e., how you get new users) is the biggest constraint.

And any improvement not at the biggest constraint is an illusion. For the same reason there’s no way to strengthen a chain without strengthening its weakest link.

We realized this 6 months in. We started focusing our efforts solely on that critical constraint – building our user base and onboarding flow.

We did get to 300K users. And then we hit a different critical constraint, one that we couldn’t solve. Another story for another day.

Any progress not at the constraint is a trick you’re playing on yourself.

I’ve been angel investing in startups for the last 3+ years, with middling success. It was only recently (after a 10x exit, as it happens), that I realized the critical constraint. The structure of angel investing itself.

Until I solve for that (work in progress), I won’t be more successful.

I wrote about this as well in Drunkards and Streetlights:

…the hardest part is finding the best companies.

Even if you’re almost psychic at picking winners, you can only pick winners among the startups you see (i.e., under your streetlight).

And in a power law world (which the world of startups certainly is), one startup makes all the difference. What if it’s one you just missed investing in? That one networking dinner you missed. That one week you were on holiday. The unicorn is just 5m away from your streetlight, but completely in the dark.

And it doesn’t end there. Even if you do find tomorrow’s billion dollar company, so will other, bigger institutional investors. And they will have no remorse muscling you out, as Paige Craig found out with Airbnb….

But let’s say you clear this hurdle as well. …What happens then?

Congratulations. You get muscled out in the next big round. This happened to me and OperatorVC.

OK then. So what do we do?

A cliche (or two) is a good place to start.

First, take a step back.

It’s important to see the larger picture. And you can’t do that when you’re busy solving a problem in some tiny nook of your system.

Next, make a list.

Step #1: Define your objective function: What is the definition of “victory” here?

This may sound trivial, but it isn’t. Far too often, you realize that you (and your team) might not be optimizing for the truly important stuff.

Step #2: Make a list of all the factors that will help you achieve this victory. Be as detailed (or not) as you want.

Important to think broad enough.

If your objective function is “Improving profitability”, just listing all the cost heads isn’t enough.

Far too often, the biggest factor driving (or constraining) profitability is revenue. There’s a limit to how much you can cut, but no limit to how much you can earn.

Similarly, the environment often plays a disproportionate role, but we ignore it. For example, the biggest constraint on your productivity is often in the environment, rather than in your process.

Step #3: Identify the most critical constraint.

This is deceptive. Sometimes the most critical constraint is obvious. At other times, it isn’t.

It helps to ask, for each of the factors listed: “If I make a 20% improvement in this element, will it drive a 20% improvement in the overall outcome?”

That’ll get you thinking. “Yes, improving the efficiency of the finishing machine will help! Oh, but wait a sec – actually then it’ll just bunch up at quality control.”

Remember – at any time, there’s always ONE constraint that’s more critical than others.

Step #4: Fix the critical constraint, and then go back to Step 3 (now there’ll be a new most critical constraint).

A couple of examples.

Taylor Pearson has a great example from business, in his article: Business Strategy: A Framework for Growing Any Business.

Source: Business Strategy: A Framework for Growing Any Business

Start with the four big heads, and see which is a bottleneck. e.g., Let’s say it’s Personal operations. Then you dive in, and figure out which sub-head is causing the problem. And then you solve for that. Repeat.

This is also something I faced when I was trying to increase my writing throughput.

I used to feel that I’m not reading enough, and that was hampering my writing (due to inadequate source material).

But when I thought about it (and looked at my notes), I realized that I was actually reading enough. It’s just that I wasn’t processing the notes fast enough. i.e., that’s the bottleneck I need to solve for.

Therefore, now, whether or not I read any new articles / books, I reflect and write everyday.

Soon, the bottleneck might shift back to the top of the funnel. I’ll be ready.

Hope you liked the article. If you’d like to receive more such articles directly in your inbox, don’t forget to subscribe to Sunday Reads!

The best of Jitha.me – A Compilation

jitha

Today I send out the 100th issue of Sunday Reads. It’s a good time to look back.

So I’m compiling some of the most well-received articles I’ve written over the last few years. On startups, business and management, and on mental models that make us more effective at what we do.

Hope you find the articles useful! Don’t read them all at once. Read whatever catches your fancy. You can always come back later ?.

[PS. It’s also a good time to subscribe if you haven’t. You’ll get issue #101 next Sunday. I promise you won’t regret it.]

The World of Startups

How to save yourself from a bad startup idea that looks good.

(Go to article).

This is an article I wrote in late 2015, a couple of years into my startup and when I was just starting OperatorVC, the angel fund I invest through.

It struck a chord with readers. It still gets 100+ views a week (and ranks in top 3 on Google for “bad startup idea”) despite being not very optimized for search.

We have plenty of startup ideas. Many of them are bad, and we dismiss them right away (or our friends warn us off the idea).

They’re the easy ones.

The dangerous ones are the ideas that look quite good. The ones that give you goosebumps, and then three wasted years.

In this article, I list some of the common patterns that such plausible (but actually bad) ideas have, so that you can spot them early and save your time.

Read on here.

On a related note: Why describing your startup as the “Uber of X” is a bad idea. Yes, despite what Y-Combinator says.

How Uber solved its Chicken and Egg problem (and you can too!).

(Go to article).

Some of the most exciting companies of the 2000s are multi-sided networks. Think Uber, or Airbnb, or even ecommerce marketplaces. They’re massive, and they have immense defensibility.

Anyone who wants to compete needs to get both suppliers and consumers, at the same time.

That’s the proverbial chicken and egg problem. How do you get consumers when you don’t have suppliers, and vice versa?

Turns out there are four specific ways you can solve the chicken and egg problem.

Read on here for examples of each of these solutions.

I’ve also captured it as a framework on Slideshare, that you can download.

Your Minimum Viable Product can be more minimum than you think.

(Go to article).

Most of us in the startup community understand the concept of a Minimum Viable Product, or MVP. It’s the most basic version of your product that still delivers your core offering.

Aiming for an MVP helps entrepreneurs (especially first-timers) avoid the rookie mistake – building too much product before validating market need. We all want the ten revolutionary features in our first version. But not only will these features take five extra months to build, most users will also not see them.

So that’s the concept of an MVP. Sounds simple, right?

And yet, we slog for 3 months to build the MVP. And congratulate ourselves on finding out it didn’t work, and then spend another 3 months on a pivot.

Three months is way too long! Why does the MVP take so long?

The reason is that we’ve got the notion of an MVP all wrong.

Read on here.

The World of Business and Management

What I learnt from talking toilets in rural Bihar.

(Go to article).

My last project in consulting (back in 2012) was to develop a market-based solution to the problem of sanitation in rural Bihar (one of India’s poorest states).

At that time, less than 20% of households in rural Bihar had toilets. And many of those who did have toilets, didn’t use them – they would defecate in the open instead.

Against this intimidating backdrop, we set out to build a private-sector led solution to the problem.

And we were fairly successful. The project helped over 500K rural households construct toilets in their homes. It increased the number of toilets in our focus districts by 10 percentage points.

This article talks about the timeless lessons I learned through the project, on markets, consumers, and how to sell.

On a related note, the job to be done framework. Or, as they say, “You don’t sell saddles. You sell a better way to ride.”

What doesn’t get measured… doesn’t exist?

(Go to article).

We’ve all heard the saying “What gets measured, gets managed”.

A simple, yet powerful thought. With a simple corollary – what doesn’t get measured, doesn’t get managed.

But in reality, the corollary is far more extreme.

In the eyes of the person responsible, what doesn’t get measured… doesn’t really exist!

Read on here, to see the dark flipside of this common management adage.

On a related note, the Availability heuristic. Or “what you see is all there is”.

How to manage your team LIKE A BOSS (even while working remote).

(Go to article).

This is a more recent, and more topical article.

Effective team management (whether in-person or remote) can be distilled into five key axioms.

Call them the Minimum Effective Dose, or the 80:20 of team management.

Team management 101

Read on here .

Hiring Great People.

(Go to article).

This links back to the previous article. You can only work with people you end up hiring. So, hiring well has an inordinate influence on your team’s future output.

Hire well, and you have an NFL Dream Team. Hire badly, and at best you get a squabbling dysfunctional family. Not much effective team management you can do there.

In the same vein as the previous article, here are 7 key learnings on hiring.

1. Hire only when you absolutely need to.

2. Don’t be too hard on yourself. 1 in 3 hires don’t work out – if you do it right.

3. False Positives are OK. False Negatives are not.

4. What to look for in candidates: drive and self-motivation, innate curiosity, and ethics.

5. A few tips for running an interview process. Most important one – do reference checks.

6. How to let people go. Decisively, but with sensitivity. It’s your fault – not theirs – that you hired them into a role where they can’t succeed.

7. Diversity will not happen on its own. You’ve got to make it happen.

Read on here.

The World of Mental Models

What are “mental models”?

They are tools that help us understand the world faster and better. Instead of approaching every new problem from scratch.

Simple but powerful concepts, that help us understand situations more clearly, and make quicker yet better decisions.

For example, take this core principle from economics: “There ain’t no such thing as a free lunch“. It reminds us to look at every wonderful business deal with care. What’s the catch? There’s always a catch.

In a way, mental models help us think in a more “modular” fashion.

Modular programming makes software much faster. In the same way, mental models are the modules that soup up your decision-making engine.

Mental models are the modules that soup up your decision-making engine.

Over the years, I’ve written about a few powerful mental models, that have helped me think faster (and better) about business problems.

Listing a few of them below.

Hope you like some of these articles!

Do write back or comment with the articles you liked best, and I’ll share more on those topics in the coming weeks.

And don’t forget to subscribe, so you get issue #101 of Sunday Reads!

Zero to One, Peter Thiel (10/10)

jitha

Zero to One is a powerful book, that changed how I thought about entrepreneurship. I’ve written about the importance of the Power Law before, and what it means for what you choose to do.

(Check out the book on Amazon here.)

To get more such book summaries every week, along with other great reads on startups, business, and tech, don’t forget to sign up below.

What do you know that others don’t?

  • What valuable company is no one building?
  • Creating value is not hard; capturing enough of that value is harder
    • In 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to Google, which creates less value but captures far more. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry’s profit margin that year.
  • Progress can take one of two forms
    • Horizontal or extensive progress means copying things that work—going from 1 to n. Horizontal progress is easy to imagine because we already know what it looks like
    • Vertical or intensive progress means doing new things—going from 0 to 1. Vertical progress is harder to imagine because it requires doing something nobody else has ever done. If you take one typewriter and build 100, you have made horizontal progress. If you have a typewriter and build a word processor, you have made vertical progress.
  • If you focus on near-term growth above all else, you miss the most important question you should be asking: will this business still be around a decade from now?
    • In March 2001, PayPal had yet to make a profit but our revenues were growing 100% year-over-year. When I projected our future cash flows, I found that 75% of the company’s present value would come from profits generated in 2011 and beyond—hard to believe for a company that had been in business for only 27 months. But even that turned out to be an underestimation. Today, PayPal continues to grow at about 15% annually, and the discount rate is lower than a decade ago. It now appears that most of the company’s value will come from 2020 and beyond.
    • LinkedIn is another good example of a company whose value exists in the far future. As of early 2014, its market capitalization was $24.5 billion—very high for a company with less than $1 billion in revenue and only $21.6 million in net income for 2012. You might look at these numbers and conclude that investors have gone insane. But this valuation makes sense when you consider LinkedIn’s projected future cash flows.
    • The overwhelming importance of future profits is counterintuitive even in Silicon Valley. For a company to be valuable it must grow and endure, but many entrepreneurs focus only on short-term growth.

Thoughts on Monopolies

Monopolies vs. Perfect Competition

  • Monopoly is the condition of every successful business
  • Under perfect competition, in the long run no company makes an economic profit. Capitalism and competition are opposites. Capitalism is premised on the accumulation of capital, but under perfect competition all profits get competed away.
  • If you want to capture value, don’t build an undifferentiated commodity business.
  • Non-monopolists exaggerate their distinction by defining their market as the intersection of various smaller markets; monopolists, by contrast, disguise their monopoly by framing their market as the union of several large markets
  • In business, money is either an important thing or it is everything. Monopolists can afford to think about things other than making money; non-monopolists can’t.
  • If the tendency of monopoly businesses were to hold back progress, they would be dangerous and we’d be right to oppose them. But the history of progress is a history of better monopoly businesses replacing incumbents.
    • A monopoly like Google is different. Since it doesn’t have to worry about competing with anyone, it has wider latitude to care about its workers, its products, and its impact on the wider world. Google’s motto—“Don’t be evil”—is in part a branding ploy, but it’s also characteristic of a kind of business that’s successful enough to take ethics seriously without jeopardizing its own existence.
  • Winning is better than losing, but everybody loses when the war isn’t one worth fighting.
    • Just as war cost the Montagues and Capulets their children, it cost Microsoft and Google their dominance: Apple came along and overtook them all. In January 2013, Apple’s market capitalization was $500 billion, while Google and Microsoft combined were worth $467 billion. Just three years before, Microsoft and Google were each more valuable than Apple. War is costly business
    • When Pets.com folded after the dot-com crash, $300 million of investment capital disappeared with it.
    • Sometimes you do have to fight. Where that’s true, you should fight and win. There is no middle ground: either don’t throw any punches, or strike hard and end it quickly.

Monopolies and Moats

  • Every Monopoly is unique, but they usually share some combination of the following characteristics: proprietary technology, network effects, economies of scale, and branding.
    • Proprietary Tech – As a good rule of thumb, proprietary technology must be at least 10 times better than its closest substitute in some important dimension to lead to a real monopolistic advantage. The clearest way to make a 10x improvement is to invent something completely new.
    • Network effects: Network effects can be powerful, but you’ll never reap them unless your product is valuable to its very first users when the network is necessarily small.
      • Network effects businesses must start with especially small markets. Facebook started with just Harvard students — Mark Zuckerberg’s first product was designed to get all his classmates signed up, not to attract all people of Earth.
      • This is why successful network businesses rarely get started by MBA types: the initial markets are so small that they often don’t even appear to be business opportunities at all.
    • Economies of scale: A good startup should have the potential for great scale built into its first design.
    • Strong brand: other monopolistic advantages are less obvious than Apple’s sparkling brand, but they are the fundamentals that let the branding effectively reinforce Apple’s monopoly.
      • Beginning with brand rather than substance is dangerous.

Building a Monopoly as a Startup

  • Every startup is small at the start. Every Monopoly dominates a large share of its market. Therefore, every startup should start with a very small market. Always err on the side of starting too small. The reason is simple: it’s easier to dominate a small market than a large one.
  • The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors. Any big market is a bad choice, and a big market already served by competing companies is even worse.
  • It’s always a red flag when entrepreneurs talk about getting 1% of a $100 billion market. In practice, a large market will either lack a good starting point or it will be open to competition, so it’s hard to ever reach that 1%. And even if you do succeed in gaining a small foothold, you’ll have to be satisfied with keeping the lights on: cutthroat competition means your profits will be zero.
  • Sequencing markets correctly is underrated, and it takes discipline to expand gradually.
    • The most successful companies make the core progression—to first dominate a specific niche and then scale to adjacent markets—a part of their founding narrative (related to Crossing the Chasm – I’ll add book notes soon)
    • As you craft a plan to expand to adjacent markets, don’t disrupt: avoid competition as much as possible.

Control over distribution

  • Superior sales and distribution by itself can create a Monopoly, even with no product differentiation. The converse is not true. No matter how strong your product—even if it easily fits into already established habits and anybody who tries it likes it immediately—you must still support it with a strong distribution plan.
  • In between personal sales (salespeople obviously required) and traditional advertising (no salespeople required) there is a dead zone – the distribution doldrums.
    • Suppose you create a software service that helps convenience store owners track their inventory and manage ordering. For a product priced around $1,000, there might be no good distribution channel to reach the small businesses that might buy it.
      • Even if you have a clear value proposition, how do you get people to hear it? Advertising would either be too broad (there’s no TV channel that only convenience store owners watch) or too inefficient (on its own, an ad in Convenience Store News probably won’t convince any owner to part with $1,000 a year).
      • The product needs a personal sales effort, but at that price point, you simply don’t have the resources to send an actual person to talk to every prospective customer.
    • This is why so many small and medium-sized businesses don’t use tools that bigger firms take for granted. It’s not that small business proprietors are unusually backward or that good tools don’t exist: distribution is the hidden bottleneck.
  • Advertising can work for startups, too, but only when your customer acquisition costs and customer lifetime value make every other distribution channel uneconomical.
  • Whoever is first to dominate the most important segment of a market with viral potential will be the last mover in the whole market.
  • If you can get just one distribution channel to work, you have a great business. If you try for several but don’t nail one, you’re finished.

Power Laws (the most interesting part of the book)

Never underestimate Exponential Growth, Compounding, and the Power Law distribution. The Power Law distribution—so named because exponential equations describe severely unequal distributions—is the law of the universe. It defines our surroundings so completely that we usually don’t even see it.

Venture Investing returns are Power Law distributions

  • The error lies in expecting that venture returns will be normally distributed: that is, bad companies will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x. Assuming this bland pattern, investors assemble a diversified portfolio and hope that winners counterbalance losers. But this “spray and pray” approach usually produces an entire portfolio of flops, with no hits at all. This is because venture returns don’t follow a normal distribution overall.
    • Our results at Founders Fund illustrate this skewed pattern: Facebook, the best investment in our 2005 fund, returned more than all the others combined.
    • Palantir, the second-best investment, is set to return more than the sum of every other investment aside from Facebook.
    • This highly uneven pattern is not unusual: we see it in all our other funds as well.
  • The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.
  • This suggests two very strange rules for VCs
    • First, only invest in companies that have the potential to return the value of the entire fund. This is a scary rule, because it eliminates the vast majority of possible investments.
    • Second: because rule number one is so restrictive, there can’t be any other rules.
  • Consider what happens when you break the first rule. a16z invested $250,000 in Instagram in 2010. When Facebook bought Instagram just two years later for $1 billion, a16z netted $78 million—a 312x return in less than two years. That’s a phenomenal return, befitting the firm’s reputation as one of the Valley’s best. But in a weird way it’s not nearly enough, because it has a $1.5 billion fund: if they only wrote $250,000 checks, they would need to find 19 Instagrams just to break even.
  • This is why investors typically put a lot more money into any company worth funding; investors who understand power laws invest in as few companies as possible
  • The power law means that differences between companies will dwarf the differences in roles inside companies. You could have 100% of the equity if you fully fund your own venture, but if it fails you’ll have 100% of nothing. Owning just 0.01% of Google, by contrast, is incredibly valuable (more than $35 million as of this writing).

What you work on matters far more than doing it well

  • Every university believes in “excellence,” and hundred-page course catalogs arranged alphabetically according to arbitrary departments of knowledge seem designed to reassure you that “it doesn’t matter what you do, as long as you do it well.” That is completely false. It does matter what you do. You should focus relentlessly on something you’re good at doing, but before that you must think hard about whether it will be valuable in the future.
  • If you do start your own company, you must remember the power law to operate it well
    • The most important things are singular: One market will probably be better than all others
    • One distribution strategy usually dominates all others, too
    • Time and decision-making themselves follow a power law, and some moments matter far more than others
  • in a power law world, you can’t afford not to think hard about where your actions will fall on the curve.

Seven questions every business must answer

  1. The Engineering Question: Can you create breakthrough technology instead of incremental improvements?
  2. The Timing Question: Is now the right time to start your particular business?
  3. The Monopoly Question: Are you starting with a big share of a small market?
  4. The People Question: Do you have the right team?
  5. The Distribution Question: Do you have a way to not just create but deliver your product?
  6. The Durability Question: Will your market position be defensible 10 and 20 years into the future?
  7. The “secret” Question: Have you identified a unique opportunity that others don’t see?

The book also illustrates how very few cleantech businesses have survived, using these seven questions.

To get more such book summaries every week, along with other great reads on startups, business, and tech, don’t forget to sign up below.

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Google’s mistake, and the importance of thinking from first principles

jitha 1 Comment

[Note: I shared this mental model with my email subscribers on Oct 23, 2016. If you want to receive a new mental model every week, join the club.]

 

Who do you think will win the war between Google and Apple?

That was a trick question. There really doesn’t need to be a war between the two companies.

 

Apple makes money when people buy its products, while Google makes money when people use its services. Apple is a vertical company, while Google is a horizontal player.

But don’t feel bad for missing the trick. Google missed it too, when they framed the fight as Google vs. iPhone. When it was really Samsung vs. iPhone.

 

Why did they make this mistake? Why did they, for example, release turn-by-turn navigation on Maps only for Android, and give Apple a reason to launch its own Maps?

Start with first principles.

Didn’t think from first principles

As Ben Thompson explains in Google and the Limits of Strategy, they got too caught up in the Android-iPhone us-them framing, without realizing that they’re fundamentally different companies, with no need to compete!

Mike McCue (CEO, Flipboard) highlights the importance of such first-principles thinking from his own experience, in The Most Powerful Lesson in Business.

Elon Musk used this thinking tool too, to reduce the cost of building a rocket. By 98%!!

 

Key Learning:

When making an important decision, examine your beliefs first. Start with a simple question: “What do we know to be absolutely true?”

[fancy_box id=5][content_upgrade id=606]Want to get new mental models straight to your inbox? The next one arrives this Sunday – don’t miss it![/content_upgrade][/fancy_box]

[Aside: First-principles thinking is useful when raising capital for your startup too, as I mention in Fundraising Mistake #7: Describing your startup as “Uber of X”]

 

Linked to: The Map is not the Territory

Filed Under: Decision-making

Fundraising Mistake #7: Describing your startup as “Uber of X”

jitha 2 Comments

[A version of this article first appeared in The Quint.]

As a seed-stage investor at OperatorVC, I see at least 50 startups a month that are looking to raise a seed round. Most pitches aren’t perfect. That’s usually OK – a founder’s core competency should be building, not pitching.

But one of the most egregious mistakes is calling yourself the “Uber of X”, or the “Airbnb of Y”.

The moment you say this, the pitch ceases to remain credible.

This is such a common refrain – and such a rookie mistake – that I can’t help but point it out.

Startups ain't Star Trek, but I feel Picard's pain.

Startups ain’t Star Trek, but I feel Picard’s pain.

I think the “X of Y” epidemic started with Y Combinator’s application process. The How to Apply page mentions that YC likes hearing “X of Y”. It helps them place the startup into the pantheon of successful companies they’ve seen.

It makes sense for YC. When they have to scour thousands of startups in a short time to select a few, a metaphor helps. “Hi, I’m the Uber of bicycles.” Enough, let’s move on.

But most fundraising pitches are not YC applications or Demo Days. Yet, Paul Graham’s words are gospel. So everyone and their next-door founder has adopted this with great gusto.

Even in situations where it doesn’t make sense.

And it’s gotten to a point where it’s almost ludicrous! I’ve heard a startup describe itself as “the BikeBob of X”. Have you heard of BikeBob? Neither have I!
[Note: I’ve disguised the real name of “BikeBob”, but trust me, you haven’t heard of it.]

Let’s be clear – this is not a “done thing”. It’s not a “best practice”. It’s a mistake, in most pitching situations. Even if it’s Uber you’re comparing yourself to, and not BikeBob or MotorcycleMary.

Before digging into why it’s a mistake, there’s an even more basic question. Why do we do it? Fierce individualists that we are, why do we willingly attach our identities to something else?

Why do we do it?

Three reasons:

  • Helps explain the product. This is why it’s recommended for YC Demo Day.
  • Shows a pattern. We all know that VCs are in the pattern recognition business. This just makes it easy for them to realize that you’re the next Uber. They better chase you with their money!
  • An attractive narrative. Starting up is hard. It’s difficult to justify to your family – and yourself – why you’re abandoning a stable ship. In such a scenario, who wouldn’t like a little ego boost?

Saying you’re Uber of X is awesome. Wouldn’t you love to equate your startup to a unicorn?

But the moment I hear it in a startup pitch, it’s hard not to cringe. Why?

Why is it a mistake?

1. Gives the impression that you’re not solving a real problem.

It sounds like you just read about a successful startup’s business model, and applied it to the first sector you could think of.

“AirBnb for cars: rent other people’s cars when they aren’t using them.”

It’s like you went to the neighborhood workshop and bought yourself a hammer. Now everything looks like a nail!

Unless an idea has formed organically from a real problem, it’s probably a bad startup idea.

[Side note: this is just one characteristic of a startup idea that sounds good, but is probably bad. Click here for a full list of such characteristics.]

"Do you want a bicycle at this very moment?" "Not really, but your speakers look awesome!"

“Do you want a bicycle at this very moment?” “Not really, but your speakers look awesome!”

Sometimes, it’s a real problem all right. But the solution doesn’t make sense.

An “Uber of intercity B2B logistics” is OK from a problem perspective. Manufacturing companies do need intercity logistics.

But do they need it on-demand? No! A huge majority of customers transport loads often, on predictable timelines. They’d prefer negotiating longer-term contracts.

I once thought of applying the Airbnb model to books.

Once I finish a book, it’s lying on my bookshelf. Wouldn’t it make sense to lend it out to others who may want to read it?

The problem is real – I need to buy a book to read it. But is this the best solution at scale? No. Not in a world where book prices are falling, e-retailers offer one-day delivery, and you can download a Kindle book in an instant.

Do I know the problem exists? In some cases, yes. In most cases, no. All I know is that the solution has worked. In another, unrelated sector.

2. It can constrain your imagination.

The moment you start calling yourself “Uber of X”, you constrain your thinking. You fool yourself into believing you have a foolproof playbook. When in fact there are important nuances and differences that are critical to consider.

When Taxi for Sure started, one initial focus area was inter-city cabs. Do you think they’d have discovered the lucrative on-demand taxi market if they called themselves the “Redbus of taxis”?

Oyo Rooms, a successful startup in its own right, could have called itself “Airbnb of hotels”. But would that have worked? Would the founder have made the same decisions? It’s possible. But not probable.

3. It’s another stake in the ground you must defend.

VCs are in the business of pattern recognition. They’ve internalized the patterns of successful startups to a level you never will.

They’ll point out nuances of those playbooks that don’t apply in your case.

I once saw a startup that was building the “Oyo of manufacturing”. Just like Oyo helps hotels use their idle capacity, this founder would help manufacturers deploy theirs. Only two tiny chinks in his plan:

  1. Hotels have average capacity utilizations of around 60%. Manufacturers have much higher utilizations. And moreover, they don’t want to be at 100% – flexibility is important. If a plant has 80% utilization, there’s no idle capacity.
  2. Unlike hotels, production is stable. A plant owner doesn’t want one-off users. He’d prefer someone who promises orders for at least 6 months.

Pattern recognition has a flipside too. An average VC sees 500 pitches every year, to select 3-4. So, they’re far more well-versed in the patterns of bad startups than good ones. Be ready for sweeping statements!

VCs are far better at identifying bad startups than good ones.

[I’ve shared a more comprehensive list of patterns seen in bad startup ideas before.]

So what should you do instead?

Fundraising 101. Explain the problem you’re solving. Explain why it’s an important problem to solve. Then show your traction.

Or flip the order, if your traction is more compelling than your problem description.

These are the two most important things, for your investors to make money. They’ll be listening hard.

Not only does this avoid the pitfalls above, it also serves your original reasons better:

1. It’s much easier to explain.

The problem is now self-evident, and there’s a clear line-of-sight from problem to solution.

2. VCs would prefer identifying the patterns themselves.

Let’s say you’re trying to solve a particularly hard logical puzzle. Would you prefer it if your friend told you the answer, or would you rather figure it out yourself?

So it is with investors as well (at least with me). It’s my job to predict the future, and I’ll feel more fulfilled if I detect the pattern myself.

This may not be flamboyant. But it’ll be a better ego boost when a VC tells you that you’re the Uber of X!

TL:DR

  • Calling your startup “X of Y” while pitching to investors is a mistake.
  • It sounds like you’re replicating an existing model, rather than making an original attempt to solve a real problem.
  • It can also constrain your thinking.
  • Instead, simply state the problem you’re solving and how you’re solving it.
  • Leave the pattern-recognition to the investors.

PS. A far more insidious version of the “X of Y” template is “X of India”. I’ve written about it in this article.

PPS. I’m calling this “fundraising mistake #7” because (a) there are several other mistakes; and (b) I want to goad myself to put the rest of them down. So watch this space.

WARNING: Too much focus can constrain your startup

jitha 1 Comment

Successful entrepreneurs, investors and strategy experts all extol the virtues of focus. I have as well, as a strategy consultant, then a founder, a writer, and now as a seed stage investor at OperatorVC.

“If you focus on a small segment, you can own it, dominate it.”

So the conventional wisdom goes.

But there are times when focus can constrain a startup from achieving its potential. When you become a big fish in a small pond, while there are gloriously large oceans just around the corner.

How do you know which is which? How do you know when to focus, and when to extend?

Perils_of_focus

This came up in a conversation with Ankesh Kothari, a fellow entrepreneur and seed investor. He highlighted how a lot of startups focus too narrowly on a small market, and never expand. And we often see the opposite at OperatorVC. Startups trying to solve problems across a broad swathe of consumers from the outset. “Microsoft Office products that solve everyone’s problems”, as I call them here.

Here’s what’s interesting: neither of these is always the right answer.

Sometimes, you have to focus on a specific consumer segment. Make sure you solve a need deeply. At other times, you need to expand your horizons.

If you focus too acutely, you’ll never become a $100 million company.

This is not intuitive. You can’t be deep in the weeds one moment, and flying at 20,000 feet the next.

Great founders can alternate between these two opposite behaviors well. And legendary founders plan for this in advance.

Exhibit A: Elon Musk’s Master Plan for Tesla.

Before Tesla started, Musk anticipated when he would focus. And when he would extend lower in the price pyramid. And he wrote it all in a badass blog post, for all the world to see.

[Tweet “If you focus too acutely, you’ll never become a $100 million company.”]

So how can you be more like Elon Musk?

At its very basic, it’s three simple steps:

  1. Start with extreme focus. Focus on a narrow segment. Serve that segment’s needs so completely that you build a monopoly in it. Focus on a city, community, or neighborhood, and then OWN it
  2. Then, expand into an adjacent segment
  3. Repeat steps 1 and 2.

 

Several great startup successes have done exactly this:

  • Facebook: Started with a student listing, just for Harvard. Once Zuckerberg found product-market fit there, he then expanded to other universities. And then the rest of the world.
  • Uber: Started as a premium limo service. Only for select customers, only in San Francisco. Today, there’s a good chance you’re reading this sitting in an Uber.
  • In the 70s, two Harvard geeks built a simple Basic interpreter for the Altair, a decidedly non-popular microcomputer. How would that ever grow big? It did. You might have heard of Microsoft.
  • Oracle has done this scores of times, sometimes even pivoting at scale to a new, much larger market.

 

Now, I know what you’re saying. Hindsight is 20:20.

Is this just one of those clichés that you retrofit to success stories? Or is there actually a lesson here for people just starting out?

 

Is it even possible to be more like Elon Musk?

The Chasm model of product adoption is a great framework to know when to focus, and when to extend.

Chasm Model

At the trivial level, we all know this. Tech enthusiasts and early adopters will use your product first. The mass market (the Early Majority or “Pragmatists”) will gradually start using it later.

But the Chasm Model offers two new insights:

  1. There’s a “chasm” between the early adopters and the mass market (the early majority). It’s very hard to make that leap, and many startups die trying.
  2. Unlike the early adopters, the early majority aren’t interested in your tech. They are interested in its application to their most important needs.

And therein lies the way.

 

When to focus

Focus when you’re crossing the chasm.

Focus on a single narrow niche within the mass market. Understand that niche and its most important needs. Create an application of your technology tailored to that segment’s needs. Find product-market fit, and cement your place there. Own that niche.

  • Tesla first focused on the luxury segment. It built a perfect car. So good it broke the Consumer Reports rating system. Oh, and it was electric too.
  • Let’s take an example we’ve seen at OperatorVC. Say you’re building an AI based system to help people recover from illnesses. Don’t start coding algorithms for all the million diseases that are possible. Don’t even start with the 100 most prevalent diseases. Start with one disease. Just ONE.

 

When to extend

Extend once you own that first segment.

Select the next niche(s) in the mass market that you want to own. Again, design applications of your technology for those segments.

And REPEAT.

  • This is exactly what Tesla is doing now, working its way down the price segments.
  • Once the healthcare bot is perfect for that one disease, it’ll be much easier to expand to the next disease. And the next hundred.

[Tweet “Be like Elon Musk. Focus first. And then extend to own the world.”]

So, when you’re starting off, make sure you focus on a segment you can really own. But also be ready to extend later, so you can own the market.

Niche to win, baby. But then parlay.

[Tweet “Let focus be your superpower. But don’t let it become your kryptonite.”]

PS. Focus is really a superpower. See how focus can be a competitive advantage.

PPS. Read Crossing the Chasm. Few books have a higher wisdom / word ratio.

[A version of this article appeared in Yourstory on Oct 10, 2016]

5 remarkable ideas that transformed how I think in 2015

jitha

Ideas_Bookshelf

Regular readers of this blog and my newsletter (subscribe here if you haven’t!) know that I’m an avid reader. 2015, for me, was a year of quantity. I read 60+ books, and at least ten times as many articles.

Some of these were bad, some good, and some changed my perspective on work and life.

I could list the top 5 books I read in the year. But instead, let me present the top 5 ideas that transformed my thinking, and the books I found them in.

[Note: You can find my 2014 list here.]

1. Keystone Habit – One Habit to Rule Them All (The Power of Habit)

I’ve written before about Thinking, Fast and Slow, and the difference between System 1 and System 2 thinking. The former is rapid, automatic, instinctive and judgmental. The latter is slower, more considered and analytical, and more effortful.

In most situations, we tend to use the quick-and-dirty System 1. The more methodical System 2 is quite lazy.

This proclivity to use System 1 underlines the importance of habits. Such sequential, repetitive tasks are so ingrained that we do them without thinking. The essence of System 1.

For instance, do you think when you’re brushing your teeth in the morning? More likely you’re so woozy you can’t walk straight. Still, your teeth are sparkling clean by the end of it.

That’s the power of habits – you can do certain tasks without thinking.

To understand more about habits, I read two books this year – Hooked and The Power of Habit. They talk a lot about the structure of habits, how to build good habits, how to break bad habits, etc.

But the most powerful concept to me was that of the keystone habit. Keystone habits are small, narrow habits in one area of your life that impact several other areas in a significant manner.

As Charles Duhigg says in The Power of Habit:

Some habits have the power to start a chain reaction, changing other habits as they move through an organization. Some habits, in other words, matter more than others in remaking businesses and lives. These are “keystone habits,” and they can influence how people work, eat, play, live, spend, and communicate. Keystone habits start a process that, over time, transforms everything.

A few examples of this are:

  1. Exercise. When you start exercising, even if only once a week, it triggers changes in various other areas. You start eating better. You become more productive and confident at work. You show more patience towards your family and colleagues. All because of a few push-ups once a week. That’s a keystone habit.
  2. Making your bed every morning. It’s a tiny, almost irrelevant change. But studies show that this correlates with better productivity, greater well-being, and more willpower.
  3. Willpower. This is the most important keystone habit. Studies show that willpower in children is the most accurate indicator of academic performance throughout their student lives. Even more accurate than IQ.

At an organizational level as well, keystone habits can have transformative impact. The book cites an example of how a worker safety program at Alcoa ended up not only improving safety, but also turning Alcoa into a profit machine.

How do these small, unrelated habits have such widespread impact? In Duhigg’s own words:

Small wins fuel transformative changes by leveraging tiny advantages into patterns that convince people that bigger achievements are within reach.

So what are your keystone habits at life and work?

Books: The Power of Habit, Hooked

Further Reading: Pregnant mothers – the holy grail of retail; Keystone habits: why they are important, and how you can build them effortlessly

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2. Rewards and their Unintended Consequences (Drive)

Incentives are strange, powerful beasts. Whether it’s pocket money we give children for doing household tasks or bonuses our bosses give us for exceeding sales targets, incentives play a key role in driving us to perform.

As Charlie Munger, legendary investor, says in his famous Psychology of Human Misjudgment speech,

I think I’ve been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.

Given the immense power of incentives, it becomes all the more important to design them right. If they’re even slightly misaligned, they can “damage civilization” (Munger’s words, a tad hyperbolic).

I read Drive earlier this year – an insightful book on the powers of rewards. The book also talks about the negative influences of incentives, if not designed well.

  1. Incentives can drown out intrinsic motivation, even when you’re doing a task you enjoy. If you receive an incentive for doing something, you also receive a subliminal message that the task is not worth doing without the incentive. End result: incentives transform an interesting task into a drudge, and play into work.

[Tweet “Incentives transform an interesting task into a drudge, and play into work.”]

  1. Incentives can only give a short-term boost. Like caffeine, they’re useful when a deadline looms. But beware the energy crash that will inevitably follow.
  2. Rewards can become addictive. As Daniel Pink, the author, says – Yes, rewards motivate people. To get more rewards.
  3. Incentives do have their uses, but only for process-oriented tasks. In fact, incentives for creative tasks can impede progress. They narrow your focus at the exact moment when you need broad thinking.

The book captures many more interesting and significant implications of an innocuous, innocent incentive.

Book: Drive

Further Reading: Yes, rewards motivate people. To get more rewards.

 

3. Your MVP can be more “minimum” than you think (Lean Startup)

Most people working in the startup ecosystem are familiar with the Minimum Viable Product. The MVP is the most basic version of your product that still delivers your core offering.

It’s an important concept to keep in mind as you build a product. You don’t want to spend too much time building the first version, before realizing customers don’t want it.

I thought I’d understood the concept well. I congratulated myself as I built my first product in three months, found that people didn’t need it, and junked it. And again when I built my next product in four months, tested it with customers for three, and then pivoted it to its current form.

Then I read Lean Startup.

I realized then that I’d taken far too long to build my MVP. What’s more – so had everyone else I know. Why do we all take so damn long to build an MVP?

The reason is that we’ve got the concept wrong. You don’t need to ‘build’ an MVP. You just need to put it together.

What does that mean?

Let’s say you want to create a website offering fashion tips. You can launch in one day or less.

  1. Buy a domain. 3 hours (the actual purchase will take 2 min. But I know you’ll agonize over names for the remaining 2 hours 58. And no, the name won’t matter.)
  2. Build a landing page with Unbounce where people can ask questions or upload photos. 1 hour.
  3. Run a small Facebook campaign publicizing the site. Or tell 10 friends, and tell them to tell 10 more each. That’s your test audience. 2 hours. 

Thus, you can be up and running tomorrow! Even if you’re slow because this is your first time.

[Tweet “Your Minimum Viable Product can be more “minimum” than you think.”]

Many popular products of today hacked together such makeshift MVPs when they started. Check out the article in Further Reading for examples.

Books: Lean Startup, Four Steps to the Epiphany (focused more on the actual process of building a company in the Lean Startup way)

Further Reading: Your Minimum Viable Product can be more “Minimum” than you think; Have a great business idea? Don’t quit your job yet.

 

4. Pareto Principle & the Minimum Effective Dose (Four Hour Work Week)

Four Hour Work Week, by Tim Ferriss, is THE book to read on personal and business productivity. Unlike most productivity books and blogs, he eschews all the standard life-hacking methods (of the “shake your hips while you brush your teeth, to get some exercise” variety).

All he has to say about traditional time management is, “Forget all about it.”

[Tweet “All you need to know about traditional time management is, “Forget all about it.””]

Instead, he focuses on using the Pareto Principle, or the 80/20 rule. He uses this to introduce the concept of the Minimum Effective Dose – the smallest amount of effort for the most impact.

Whether your customers, your vendors, books you read, anything – choose the few that give you the most value, and forget about the rest.

He should know. He puts the Pareto principle on steroids. Sample this:

  1. In his nutrition products business, he “fired” the least profitable 97% (!) of his customers, to instead focus on the 3% most promising ones and double his income.
  2. He eliminated 70% of his advertising costs and almost doubled his direct sales income.
  3. He discontinued over 99% of his online affiliates.

Eliminating the least value tasks and business relationships helped him free up his time to do more productive tasks. And achieve the Holy Grail of less work but more profit. That’s how you do productivity!

Side note: In his follow up book, The Four Hour Body, Ferriss uses the concept of the Minimum Effective Dose to illustrate how to become more healthy. Check that out too.

Books: Four Hour Work Week, Four Hour Body

Further Reading: Winners don’t do things differently. They do different things., The Power of the Minimum Effective Dose

 

5. What’s your BATNA? (Getting to Yes)

One skill I tried to build last year was negotiation and persuasion. I read three great books on the subject. I’m still to have the investor conversations where I’ll use this skill, so I don’t know how much they’ve helped!

But one concept that has stuck is that of the BATNA – the Best Alternative To a Negotiated Agreement. In simple terms, the BATNA is your fall-back option in case talks fall through.

Your BATNA is tantamount to your leverage in the negotiation. It works in two ways.

1. The better your BATNA, the more leverage you have.

Let’s say you’re negotiating the sale of your house with a prospective buyer. Your alternative to this is to (a) rent it out; (b) sell it to a land developer to make a parking lot, and (c) live there yourself. If option (b), say, is the most attractive of these, then that’s your BATNA. The value the land developer offers you should form the baseline for the negotiation.

As long as the buyer’s offer is higher than this, you can reduce your price (after making a big deal of it, of course).

Far more important though, is that if the buyer pushes you below this BATNA, you can and should refuse. This is difficult. We tend to over-invest emotionally in a long negotiation. But with this hard stop in mind, you can overrule your emotions and walk away.

2. The worse you make your opponent’s BATNA, the more leverage you have.

Improving your BATNA gives you leverage. Straightforward. But there’s a more interesting insight here. You can improve your leverage by worsening your opponent’s BATNA.

Let’s say you’re the prospective buyer in the above transaction. You know that your seller is holding out because of the safety net of the land developer.

So, you remove that safety net. For example, you could sell one of your own other properties to the land developer, so he’s no longer making an offer to your seller.

By removing the most promising alternative your seller has, you’re weakening his leverage. And strengthening your own considerably.

[Tweet “Show your opponent he has a lot to lose from breaking talks, and he’ll be surprisingly pliable.”]

Books: Getting to Yes, Influence, Bargaining for Advantage

 

6. [BONUS] Focus on strengths, not lack of weaknesses (The Hard Thing about Hard Things)

By default, we are all risk averse. In fact, Loss Aversion is one of the strongest, most deep-rooted cognitive biases there is, squirming deep inside our brain’s reptilian core.

This loss aversion manifests itself in several ways. Holding on to bad-performing stocks in the hope of a turnaround. Not making bets because of high risk, even if the reward is much higher.

In the corporate environment, this results in a preference for well-rounded candidates. We tend to choose such people over others who are spiky in some areas, but middling in others. We choose average programmers with great communication skills over 10x programmers who are introverts. We reject uber-salesmen just because they don’t know much about tech.

As Ben Horowitz says in this book, that’s the exact wrong approach. That’s not how great organizations work. Instead, such organizations look for excellent candidates, who are in the top 1 percentile of their roles. Never mind that they’re not good at other things.

“Identify the strengths you want, and the weaknesses you’re willing to tolerate.”

Your Product team should have the best programmers. Even if their communication skills could be better. For sales, hire the best salesmen out there, even if they’ve not worked in your industry before.

We also tend to paper over the weaknesses and focus on repairing them. Again, not the most optimal approach. Instead, focus on honing your employees’ strengths. Plug the weaknesses (If they’re important. They often aren’t.) by hiring superstars in those areas.

[Tweet “Identify the strengths you want, and the weaknesses you’re willing to tolerate.”]

Books: The Hard Thing about Hard Things

[fancy_box id=5][content_upgrade id=463]BONUS: Get my 2016 Reading List with 40+ book recommendations![/content_upgrade][/fancy_box]

So, those were the books and ideas that captivated my thinking in the last year. Here’s to many more brilliant ideas and books in the new year. Of course, you’ll be the first to know of any great books I find (sign up here to receive regular updates!).

How to save yourself from a bad startup idea that looks good

jitha 9 Comments

Startup_Ideation

The startup bug has bitten you. You want to start a business, grow it for a few years, sell out and rest easy for the rest of your life. A great dream to have. But that’s the easy part. The hard part is building the business. And this long, arduous journey starts with a single step – having a great idea.

How do you come up with a startup idea? To start, you read this article by Paul Graham of Y-Combinator. It’s thought-provoking, even by Paul’s lofty standards. Paul says a lot about the characteristics of great ideas. But he also talks about a similar-looking but antithetical concept – the “sitcom” startup idea.

What is a sitcom startup idea? It’s one which sounds plausible, but is actually bad.

This is not just a bad idea. We have tons of those, and they are easy to identify. Even if our ownership of the idea blinds us to its infantile stupidity, our friends will warn us. They’ll tell us it’s the dumbest thing they’ve ever heard. And we can swallow our pride and move on to the next idea.

No, the sitcom startup idea is not bad in the same way. It’s an idea which sounds plausible. So plausible that when you go ask customers whether they’d use it, they don’t say no.

This is what makes it dangerous. You can read Lean Startup, dutifully ‘validate’ your idea with customers, and then build it. Only to find out that there actually is no market.

Social network for pets

Paul illustrates this with an example of a ‘social network for pets’. If you have pets, this sounds like a good idea. Sure, you can imagine posting photos of your pet parakeet on petlife.com, where others are waiting with bated breath to “like” them. Or, what’s far more insidious, you can imagine others around you loving this service.

I actually tried this during my lecture in IIM Trichy, and people loved the idea. But it’s bad on two levels:

  1. It’s erroneous to assume that if people say they like a product, they’ll use it. I might like 30 different websites, but that doesn’t mean I’ll check all of them every day. Given my limited attention span, the only social network I’ll use daily is Facebook.
  2. If you talk to 100 people and they all say they “know someone who would use this”, then you’ve found yourself a community of 100 almost-users. Or to be precise, exactly zero users.

So how do you differentiate between sitcom startup ideas, and truly promising ones? How do you know if you’re on to something huge, or just a mirage?

Mirage

The short (and hard) answer is – you try anyway. You build an MVP and check if there’s traction in the market. If there is, congratulations, it worked. If there isn’t, then you know you just had a “sitcom” idea.

But there is an easier way. I’ve come up with a few patterns to identify what is probably a bad idea, even though it sounds plausible.

Before we jump in, a caveat. I don’t know if any plausible sounding idea is actually bad. What I do know though, is that the universe of plausible ideas is much, much larger than the set of good ideas. So, an idea that is only plausible is probably bad.

Venn_diagram

Just like I know that a monkey banging away at a keyboard will not produce Romeo and Juliet (it might, but the probability is infinitesimal), if all I know about a startup idea is that it’s plausible, it’s probably bad. Sure, you get a Twitter every once in a while. A product that seems random can suddenly catch fire. But such instances are so few and far between that you can ignore them.

With that done, let’s dive in to the patterns:

1. Broad and shallow, vs. narrow and deep

One of Paul’s theses in his article is that you should solve a deep need for at least a few people. If the need you are solving is shallow, then it’s not a great startup idea. Even if it affects a broad set of customers.

It’s got to be a major problem – a mild or one-time issue won’t cut it.

You’ve got to create a product that at least a few people NEED, not one that many people WANT.

A sitcom idea of the ‘broad and shallow’ variety can follow several patterns.

A “vitamin”, not a “painkiller”

The social network for pets falls into this category. It’s a nice-to-have, like a vitamin capsule. No one needs it, like the root-canal patient who’ll pass out without a painkiller. If people just ‘want’ what you’re building but don’t ‘need’ it, tread with caution. You may be onto a bad idea that sounds good.

Instead of focusing on cool things people could use, try and solve a real problem.

Not solving a top-tier problem

But only solving a problem is not enough. It has to be important. Simply put – if the problem you’re solving is not one of your customer’s top 3 problems, it’s not important. Give up now, before it’s too late.

I once thought of building a software tool to help VCs manage deal flow. It would have a visual funnel, to tell the VC how many deals they have seen in the last 3 months, and at what stage of discussion each deal is. And they could dice it by any filter (e.g., SaaS vs. consumer, location, stage of business, etc.) to see their deal pipelines.

A great idea, I thought. The only issue – it’s not an important enough problem. Getting strong deal flow is far, far more important than tracking it. Many VCs are happy enough using Excel to track their pipelines. They’re not even trying generic funnel management systems like Salesforce. Why will they bother using one tailored for VCs?

If the problem you’re solving is not one of your customer’s top 3 problems, it’s not important.

“Solving a problem people don’t know they have”

This is a first cousin of the two patterns above. While not a “vitamin” solution per se, it’s solving a problem people don’t know they have. Which begs the question – how do you know they have this problem?

I tried doing this a couple of years ago, with a plug-and-play loyalty program for small business websites. Users would get points for coming back to the website every day, reading articles, sharing to social networks, etc.

A great idea for large, stable businesses trying to increase customer retention, maybe. But a small business finding its feet? These guys don’t even think about gamification or loyalty. They have other problems. They need to build a user base first, before trying small tricks to engineer loyalty.

I tried selling this for 6 months. It did not work. It’s hard enough convincing people to buy your product. Why do you want to add the burden of convincing them that they need it?

If you want to avoid building something no one wants, then solve known problems.

“This product solves everyone’s problems” OR the “Microsoft Office” product

I love Microsoft Office. It’s so flexible, so all-encompassing. No matter what type of problem you’re working on, you can bet that Excel and PowerPoint will be super helpful. Or think of Google – no matter your query, you can find the answer.

These are all excellent products. But aiming to solve everyone’s problems in one go can sound the death knell for startups. Why? Taking the example of my gamification system again:

  1. It’s unlikely that there’s a dire need for your product among a huge mass of people already. If you’re solving a problem for everyone, it’s probably a broad and shallow problem, not a deep one. My system was a nice-to-have, not the answer to their top 3 problems.
  2. In most cases, flexible products necessitate a learning curve among customers. Newsflash – your customers are too busy to spare any time to learn how to use yet another product. Unless you’re solving a problem as critical as the ones Office and Google solve, good luck getting adoption. It’s more sensible to focus on one type of customer, and solve their problem better than anyone else.
  3. Solving everyone’s problems at the same time requires a complex back-end. Why build that without strong market validation first? You’ll either end up building a buggy product, or worse, build a great product that no one wants. In the case of our product, the tech challenges proved intractable. Trying to integrate our system with several website technologies meant that it didn’t work well with any.

Trying to solve a problem for everyone often means you end up solving it for… no one.

“Cool product I’ve built”

You get this a lot from engineers (I’m one too). We focus on the product, because we feel that the product alone is good enough. “My cool new app allows you to share your photos with all your Whatsapp groups in one go”. Great, but what if your users don’t want that?

“Build it and they will come” doesn’t work, in this world where a million apps are fighting for people’s eyeballs. See the chart in this article to see how high the bar is. You need to be sure that you’re solving a problem, and a top-tier one. Else, you could just be a “solution searching for a problem”.

Demonstrate need first. Else, your intricate product could just be another elaborately constructed pipe dream.

2. Templatized business models

“Uber for X”

[as used in “Uber for bicycles: On-demand bicycles for your riding pleasure”, or “AirBnb for cars: Rent other people’s cars when they’re not using them”]

"Do you want a bicycle at this very moment?"

“Do you want a bicycle at this very moment?”

This template is as old as the Internet. Take what’s working in one sector, and plonk it into another. It was “Website for X” in the 90s, and “Social network for Y” in the 2000s. But it’s a dangerous stratagem. Why?

Sure, Uber has been uber-successful in the cab market. But that doesn’t mean on-demand could work for every other sector. Unless the idea has grown organically from a problem, you have to assume it’s bad. You have to assume that the founder has applied the Uber template to the first sector he could think of.

Another clue that you’re facing this situation is when founders have no real expertise in the area they’re building for. Then how do they know that the problem is real? They don’t. All they know is that the solution is real, for another sector.

“X for India”

This is an even more pervasive and notorious template. Unless the model has some kind of geographical constraint (e.g., on-demand cabs), there’s nothing stopping a successful US business from expanding to India.

Moreover, if the model involves network effects, then you’d expect something that’s grown in one place to capture share rapidly in other places too.

As Mahesh Murthy is wont to say, the Facebook of India is Facebook. The Tinder of India is Tinder, and not Woo.

There’s one more problem with this template – some models just don’t extend across geographies. On-demand bicycles may be a great idea in Scandinavia or Taiwan. But it just won’t work in hot, sultry, noisy and overcrowded Mumbai (gosh, why am I still living here?).

3. Incremental business models

This is another type of business idea that we see quite often. It often involves just a slight tweak to solutions existing in the market. Again, this can be of two types:

Cloning an existing player, but with slight improvement

Think “Uber with wi-fi”. Of course, Uber has started doing this now. But even if it didn’t, this would be a horrible idea for a startup. Wi-fi is not differentiation. It’s a cosmetic touch-up engineered solely to help you raise money from rookie investors.

It’s wrong on two levels:

  1. It assumes that the incumbent will sit idle while you bring out an improved product. If what you’re bringing to the table is only an incremental improvement (i.e., 1x, not 10x), you can bet that the incumbent will also include it in their next release, if they find out it’s a helpful add-on. Don’t assume stupidity.
  2. Often, your improvement has nothing to do with the core problem you’re solving. Wouldn’t it be silly to say, “Uber works, but people hate the fact that it doesn’t have wi-fi.”?

Cloning an existing player, but in an adjacent market

Back when Bookmyshow (a movie ticketing website in India) was only a couple of years old, a friend told me he wanted to build a “Bookmyshow for Plays”. This is a bad idea too. Bookmyshow had already solved the harder problem of getting customers. So, it was much easier for Bookmyshow to include plays on its platform, than it was for a new player to start afresh. And true enough, plays appeared on Bookmyshow a few months later.

A giveaway for this kind of sitcom idea is a statement of the form “Today’s solution is satisfactory. But mine’s much better”. For your idea to be definitively good, today’s solution cannot be satisfactory! At least for a segment of the audience. Otherwise, your idea would be like my deal flow management solution for VCs. A nice-to-have, but not nice enough to change an existing process.

What is nice enough though, to change one’s existing behavior? A 10x improvement – whether in ease, time taken, or effectiveness.

4. “No Competition”

You often hear founders say that they’re the first team to do X, and that there are no competitors. Or they may say that everyone is a competitor (which is another way of saying “no competitors”). If you hear this, run in the opposite direction as fast as you can.

Why? Why is lack of competition alarming? For two reasons:

  1. If there really is no competition, maybe the market itself is unattractive. Today, it is difficult to come across a problem that no one has seen at all. Why do you want to solve unambitious problems, when it’s just as difficult as tackling ambitious ones?
  2. The founders may not have done thorough analysis, or may be suspended in the myth that their competitive moat is bigger than it actually is. Would you want to back such founders?

Wait, so am I saying competition is actually important? Yes – many players trying to solve a problem demonstrates strong need. But to succeed, you still need to differentiate. You need to have an ‘unfair advantage’ in startup parlance. Whether industry experience, critical partnerships, etc. – you must have a secret sauce in your recipe for success.

Your competitors will not sit idle while you beat them. What’s your secret sauce?

That’s it. Those are the patterns that should raise your suspicion antennae when listening to startup ideas. Am I missing any? Let me know in the comments, send an email to [email protected], or tweet at @jithamithra.

Of course, some ideas may actually be great, even if they fit these patterns. They may end up changing the world. Only one way to find out for sure – launch an MVP, and prove me wrong.

Winners don’t do things differently. They do different things.

jitha 4 Comments

No, I haven’t made a typo in the title. The age old saying “Winners don’t do different things. They do things differently.”, made famous by Shiv Khera in his book You Can Win, is wrong.

I remember when the book came out, everyone quoted it as gospel. Every individual can be great. All you need to do is work hard, and work smart. And they would all nod knowingly at the last clause. So that’s what I did – studied hard, went to a good B-School, got a great job and worked hard (and smart) there.

Pic00003

But unfortunately, this saying isn’t true. And it’s becoming more false as technology eats the world (to co-opt Marc Andreessen’s pet phrase).

 

This mentality of doing things smarter now pervades all aspects of our life. But it suffers from one fallacy – what I call ‘focusing on the numerator’.

It’s like a company that focuses only on improving its profit margin. It brings in cutting-edge efficient machines, implements Just-in-time production techniques, and what have you. But with all these productivity improvements, how much could the profit margin increase? From 15% to 20%? 40%? 100%??

Even in the best (and impossible) scenario, the upside is capped at 100% of revenue. What if you focused, instead, on the denominator? What if you looked for ways to achieve a step jump in revenue? Suddenly, there’s far more value to capture, even if you are inefficient.

 

What you work on matters, and matters far, far more than how hard you work. This is an example of a Power law, which I’ve written about before.  In the early 1900s in England, there was a profession of people called ‘knocker-uppers’ (no, it’s not what you think). Their task was to wake people up every morning. They would walk the streets with a long stick, and tap on windows till people woke up. Many of them worked hard. I’m sure they worked smart too – with well-balanced, aerodynamic and sonorous sticks. Still, they lost their livelihoods in a jiffy when alarm clocks came into the market.

Moral of the story: Do more valuable tasks, instead of doing less valuable tasks efficiently or smartly. Doing something unimportant well does not make it important.

Pic00001

This is how the world is today – it’s the new normal. The companies that win are the ones that innovate 10X and ‘change the game’. Not the ones who innovate incrementally. As Peter Thiel says in his book, don’t move an industry to greater efficiencies (i.e., from 1 to 1.1). Focus instead on moving something from zero to one.

[Tweet “Do more valuable tasks, instead of doing less valuable tasks efficiently or smartly.”]

Look at the biggest companies around us – Google (search advertising), Apple (iPhone), Amazon (e-commerce, e-books, etc.). They didn’t just improve search algorithms, build a better phone, or sell books through a simpler distribution chain. They revolutionized their respective industries. Not by doing things differently or more efficiently, but by doing different things.

And it’s not just companies – it’s visible in every aspect of life. No longer can you say, “Karm kar, phal ki chinta na kar” (“Work hard, don’t worry about the result”) in all honesty. If the recipe sucks, it doesn’t matter how good a cook you are.

[Tweet “If the recipe sucks, it doesn’t matter how good a cook you are.”]

This may be bad news. But it’s good news as well. Once you start looking for this ‘focus on the numerator’ behavior everywhere, you can make more valuable decisions about your company, your products, and your time.

A few examples of the implications, off the top of my head:

  1. Product Management: Instead of A/B testing and optimizing your nth new feature, focus on getting more people to use your product. Andrew Chen puts this well in a recent article.
  2. HR: Instead of trying to getting the best out of your team, learn how to build a better team. [This is more important in technology businesses, and less so in traditional brick-and-mortar companies.]
  3. Health: You can try to manage your cholesterol by eating french fries cooked in refined oil or unsaturated oil or whatever the flavor of the season is. Or, you can just stop eating french fries!
  4. Personal Finance: Focus on earning more, not spending less. A direct corollary of the revenue-profit point I made earlier. It’s ironic, but I’m the prime target for this lesson. As a Tam-Brahm, I started expense budgeting almost before I could walk. I’ve spent countless hours balancing my expenses, tracking my receipts, and strategizing lower spends, when I could have instead focused on doing more valuable things. Which means anything else, basically.
  5. Personal Productivity: Be effective, not efficient, as Tim Ferriss says in The Four Hour Work Week. Do two important things, instead of 10 unimportant ones. Again, a slap on my face – so far, I was firmly in the ‘get more out of your day‘ brigade.

TL:DR: In work as in life, we should strive hard by all means. But we must think hard first – is what I’m doing the most valuable thing I could do? Let’s build more important things, instead of optimizing our lives away.

Pic00002

What do you think? Are there any other examples of ‘focus on the numerator’ behavior? Drop me an email at [email protected], comment here, or tweet at @jithamithra.

[Note: This article first appeard in Yourstory.]