Do You Have Practical Courage?

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Nobody makes Hollywood movies about characters that don’t have courage.  The warrior who goes to great lengths to put himself or herself on the line for his or her brother-in-arms.  The sports star who dared to take the game winning shot. The executive who bet the business on a new direction when the forces at play suggested otherwise. The doctor who is prepared to try an experimental treatment.  The investor who bets against market forces and wins. These are the stories of legend and heroism.  The trouble is – plenty of sports stars miss the last second shot, execs throw their companies into turbulent times with moon shots that don’t work, investors can get fired for countercyclical decisions and doctors can get sued for excessive risk-taking. How should you think about approaching your own work-life?  How should you evaluate the level of “courage” you should have when making a decision that affects your career and your business?

The answer is to have “practical courage.”  Practical courage involves making courageous decisions that lead to non-linear outcomes for yourself and your business but in a way that is inherently practical.

You can apply practical courage to a whole range of situations.  Making practically courageous choices is really hard. The temptations are on one extreme or the other. You will have a large number of people in your life telling you that the path ahead on the courageous decision is really hard, and that one should take the easier road. You will have others who prey purely on emotion. You will hear people say “greatness comes from taking a big bet blindly, believing in yourself and just doing it.”  Neither is practical courage and fighting the two polarizing forces is what practical courage involves.  Ask yourself a few questions to help you make a practically courageous choice:

  • Do you have the unfair advantage of knowledge or facts that others don’t have?  Peter Thiel calls it “the secret” in his book Zero to One.  When Mark Zuckerberg turned down a $1 billion offer from Yahoo!, he likely did not do it because he simply didn’t want to be acquired. He had knowledge about the potential impact of a social network that Yahoo! (and likely many Facebook stakeholders) just did not have.  When Andy Grove bet Intel on the microprocessor business and away from the memory business, he knew that one was a path to commoditization and the other was a path to real growth. They could make the courageous choice because they had information that the market did not.
  • Can you be practical in the short term but right in the long term?  Practically courageous choices often involve short-term – long-term tradeoffs.  If you make a big bet on a new, more risky choice that is likely to be right in the long term in a way that can be practically pulled off in the short term you have found the zone of practical courage.  The lean startup methodology that Eric Ries has talked about is inherently about practical courage. It involves rapid innovation in a clear direction, but it limits investment until early market feedback is positive.  Promoting someone with high potential can be courageous.  Promoting someone with high potential, but with a backup plan in case they fail is practically courageous.
  • Have you considered the true downside case?  I thought a lot about downside when I decided to be an entrepreneur. It can be a tough decision to leave a good job and great career prospect, until you consider the downside case. I started to think of my education and my previous work experience as an “insurance policy.” I had the good fortune of enough qualifications to get a job anytime, so what’s the real downside case of taking a bit of risk?

Being practical is a path to incremental improvements over the status quo.  Being courageous without practicality is like betting at the Casino.  But practical courage can give you a truly unfair advantage on a path to tremendous success. Developing an intuition for practical courage is not a science.  It is an art, and one that the best leaders have learned.  It involves collecting a lot of data and genuinely paying attention to it.  But it ultimately also involves having the inner strength to take a set of data points that are inherently grey and having the courage to trust your gut.

 

Image from by David Goehring licensed under CC by 2.0

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The Evolution of One Entrepreneur’s Vacations

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I know your first question.  Do entrepreneurs take vacations?  Absolutely.  I just got a chance to spend four days in a beautiful Hawaiian beach town and it made me reflect on the evolution of my vacations as a founder/ceo.  The vacation-eschewing, Jolt-cola-drinking, 24-hour-hacking founder culture is primarily the stuff of urban legend.  Entrepreneurs are like everyone else.  They burn out.  And without vacations, they burn out faster.  Any entrepreneur that believes in never taking vacations is either lying or the leader of a company that simply won’t be around very long.  Vacations are as important to the success of an entrepreneurial venture as work ethic.  In fact, if you can’t check out, you can’t be productive when you’re checked in – and that ultimately impacts your start-up’s success massively.  You certainly can’t connect with family the way you need to – and that impacts your start-up’s success massively too.

But taking a vacation as a founder is REALLY difficult.  You have an emotional connection to the company you started and can’t imagine it surviving even a day without you there.  If you’re like me, you’re typically a workaholic – and get a rush out of working a little harder.  And you live in an ultra-connected world, which means vacationing isn’t as simple as going someplace else.

I took my first vacation as a founder at least about a year and half after we started BloomReach.  We were really small then (fewer than 6 people) and the idea of one of us not being around for a week was impossible to imagine. The likely loss in velocity was just too disconcerting to contemplate.  Things got interesting when I took my first vacation.  I ended up heading to the beach, where I pretty much worked like I was at home.  The early-stage start-up vacation is simply an exercise in transplanting and pretend-vacationing.  The root problem with my early vacation was that I was too much in the flow of critical path items.  Customers needed to be signed. People needed to be recruited.  Products needed to be released. I was a bottleneck to progress in all of them. Whenever I opened my inbox, it had more emails to respond to than I had minutes to type.

As we cross the 225-person threshold at BloomReach, my vacations feel pretty different.  Sure, in Hawaii there were the one or two phone calls I absolutely had to take and re-orient my day around.  There was the occasional mind-wandering from the family back to work.  But for the most part, I checked email about twice a day and didn’t do a whole lot beyond that.  As I was on the plane ride back home – I opened my email and found that I could get through it pretty quickly. It wasn’t that there weren’t critical items for me to tackle – it’s just that none of them could be tackled via an email task list. I had about 5 big problems to think about – like an under-performing team or the long term strategy for one of our product lines or ways to continue to drive incremental growth.  All of them required a lot of thinking, significant in-person communication with key folks, some data gathering and multi-dimensional action.  Most were urgent topics, just not ones that could be tackled at a vacation in Hawaii.  The vacations changed because the role has changed.  We now have a terrific team to tackle the extremely important day-to-day challenges of the Company.  But as the team has grown, structural challenges like the topics mentioned above become more thorny and less easy to address.  Given the nature of how vacations evolve as one’s role evolves, I think an Entrepreneur should also change the way he or she takes them.  In the earlier days – take them a bit more frequently but for short bursts (a long weekend here or there).  The days are long so you need to constantly re-charge but you can’t be away very long.  As the Company grows, take them less frequently but for longer periods of time (perhaps a week or 10 days).  That might enable more of an ability to “disconnect” and greater clarity of thinking to tackle the thorny challenges.

One of my investors, Scott Sandell from NEA, advocated to me that I take a three-week complete check-out vacation every year.  I’m not enlightened enough to be there.  After four or five days, I’m pretty excited to come back to work.  But I do see his point.  As you grow in role and responsibility, the quality of your decisions become a lot more important than the quantity of actions you take.  And that quality requires a clear mind – one that comes from genuine vacations.

Loss Aversion is a Path to Mediocrity

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The story of great companies degenerating into good ones is a common one. What happened to Nokia in the cell phone industry or Dell in the computer industry? What happened to Circuit City or AOL? Even closer to home, what about companies that at one time were going to disrupt the world and went from almost great to truly mediocre? Groupon? Zynga? While different aspects of business strategy and execution were certainly at work, the one consistent factor across companies who were “almost great” or “formerly great” is that they develop a culture of loss aversion. In a strange way, the most risk-seeking of individuals, start-up entrepreneurs, can very quickly forget the greatest asset they had in building their companies – a willingness to take irrationals risks, and tolerate losses if they fail. They can quickly become loss averse and set their companies on a path to mediocrity.

Where does loss aversion come from? The author Daniel Kahneman in his book “Thinking, Fast and Slow” writes at length about loss aversion. One of his key observations is that human beings behave in irrationally risk seeking or risk averse manners (versus the probability-weighted expected value). If presented with the choice of winning a $1,000 with a 10% probability or making $120, many would be risk seeking and go for the $1,000 choice (though the expected value is lower). With losses, the opposite is true. If there is even a small chance they may lose what they have earned, people will go to great lengths to protect against the loss. They will buy insurance for exorbitant amounts. Companies will make bad long-term choices in favor of shorter term ones to protect against missing their quarterly earnings and taking a loss on the value of their stock. They will be loss averse.

The interesting thing is that many of the best companies start by being risk-seeking. They dream of amazing things – they take risks on markets, people and products. They take risks that most existing companies would not deem feasible and when those risks pay off, they pay off in significant gains. And yet, as those companies become more successful they become fundamentally risk averse. That risk or loss aversion manifests in so many ways: they under-invest in new products; they are unwilling to hire people with less experience; they spend money on risk-mitigation systems; they build in all kinds of cushions into their forecasts and they take their marketing in a conservative direction. Why do the most risk seeking of individuals, entrepreneurs, become loss averse? For a variety of reasons:

  • Short-term gain, long-term loss: As companies grow, the consequences of loss aversion are often not felt immediately. They are felt over time as investments become non-productive. But in the short term, it can often feel like the conservative decision is the winner. The experienced hire might not be the right one long term, but often looks better in the short term.
  • Fear of losing everything: It’s so hard to build a successful startup, that the pain of losing everything is nothing short of emotionally scarring. Aspiring to greatness, seeing that goal come into view and then failing is a devastating fear that pushes many leaders in a more conservative direction.
  • Baggage of success: Even a reasonable modicum of success comes with baggage. Scaling the product seems to need an unending number of people. Scaling sales and marketing seems to need an unending amount of investment. Scaling the operations can feel like the hard 20% that takes you from 80% “good enough” to 100% “great.”

We try hard at BloomReach to prevent loss aversion from naturally setting in (and don’t always succeed). We allocate a certain percentage of our R&D efforts to more experimental projects. We identify certain roles where we are willing to promote people without the experience for the role. We establish a cultural value in “thinking” – and promote out-of-the-box thinking in a range of areas. We actively have conversations about whether or not we are making the right trade-offs between “innovating” and “scaling.” We discuss failure openly. We try to ensure that the short-term choices we make are leading us to the long-term destination we are trying to reach. It gets harder and harder to make these choices as we grow and scale. And yet it becomes ever more important. Loss aversion seems to compound as one grows. Each individual becomes loss averse. Each team inherits each individual’s loss aversion and layers on a new layer of it. Each function hedges on the other functions, feeling like they cannot take risks without the cooperation of other functions. And then the CEO and founders inherit all of that loss aversion and add a new layer of conservatism for presentation to the Board and shareholders.

Loss-aversion is among the most corrosive behaviors at a startup that is aiming for significant impact and growth. The road to mediocrity is paved with a thousand “rational” decisions. Lets make sure we all make a couple of well-timed irrational ones.

Image from Risk-Onyx Edition by Derek Gavey licensed under CC by 2.0

Scaling a No-Titles Organization

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Three of the core values of BloomReach are “We”, “Own” and “No Drama.” “We” is about being on shared journey – no individual stars at the expense of the team. “Own” is about acting and behaving like an owner of the company. “No Drama” is about being a team of problem solvers – non-political and collaborative. These cultural values are tightly coupled with the core objective of many early-stage start-ups: creating an environment of little to no hierarchy and maximum creativity. Given that titles are typically a source of hierarchy, the question of how to handle the scaling of the organization while minimally introducing titles is the subject of this post.

Stage 1 – the early days

One of the earliest decisions my co-founder and I made was to establish a principle of “no titles” (full disclosure Ashutosh was always CTO and I was always CEO). The idea was born out of a desire to create an environment where those three values could really take root. In a world of large numbers of VPs, directors, senior directors and managers, the incentive system seems out of whack with the priorities of an early stage start-up. We wanted everybody to be part of “We” – not just the leaders of the company. If titles were eliminated as an issue, everyone could feel like an equal part of the journey. Everyone could feel like they were an owner. And if no one could gun for a new title, the drama quotient would be significantly reduced. Everyone in engineering was “member of technical staff.” People could be paid differently and given different levels of responsibilities – but the lack of hierarchical titles would drive a culture of equanimity. We even went so far as to word every offer letter by function rather than title. People were simply “in sales” or “in marketing.” The standard question we would get is, “How do you recruit great people to a no-titles culture?” By sticking to our guns. If we could come out and say “we have no titles at BloomReach” – it’s pretty hard for a candidate to make an argument that they deserve an exception. And those that walked away on that basis, we were happy to lose.

Stage 2 – “Head of”

As time went by, we got into the “head of” stage of the company-title evolution. We hired a “head of sales” and a “head of product”. The “head of” title was meant to signify leadership, not one’s superior position on the organizational chart. A “head of east coast sales” could report to a “head of sales”. By keeping both titles “head of,” we were continuing to send the message that we were still very much a “We” culture. We could recruit leaders if we needed to, and ensure that the efforts those people were leading could be reflected in the way they described themselves externally. The objective of adding a “head of” title was twofold – provide clarity to the external world on the role of our people and provide clarity internally on who owned a given function. We complimented the “head of” with leads. We had tech leads, marketing leads and product/account management leads. Leads were not titles – they were roles. Someone could be a tech lead for project A and a team member for project B. Stage 2 enabled us to grow up a little bit, just really slowly. And it allowed us to preserve a no-hierarchy culture in day-to-day operational life.

Stage 3 – Directors and Principal Engineers

As BloomReach’s engineering team grew we started to need real people-managers outside of the executive team. We also needed individual role models for the rest of the organization. Directors and principal engineers were born. We have always been very conservative about the criteria for these titles. The people who took them on were already clear leaders – managing complex projects and large teams or providing technical leadership across the company. The addition of directors and principal engineers provided aspirational role models, but still preserved the ethos of a “no titles” world. Since less than 5% of the team had these titles and the bar was so impossibly high – the same behavior of the early days was maintained, albeit with individuals now clearly responsible for the success of others.

Stage 4 – Peer-based promotions

Just recently we took our conservative approach to titling to a new level. As a result of clear feedback from our team that they were hungry for more readily accessible career paths, we introduced the “staff engineer” and “manager” titles in engineering. Though they may make us look a lot more traditional, it was our promotion process that preserved the essence of BloomReach values. The recently rolled out promotion process enabled a team of senior engineers and engineering directors to evaluate the contributions, cultural fit and impact of candidates. They reviewed everything – code, projects, leadership and interaction style. They set the criteria for being promoted to “manager” and “staff engineer.” They debated the merits of each individual and ultimately reached consensus. Importantly, neither my co-founder (our CTO) nor our head of development was present in those meetings. It sent a clear signal: promotions at BloomReach would not be achieved by currying favor with leadership. You succeed by earning the respect of your esteemed colleagues.

Why bother with all of this innovation around titles and promotions? If we were going to end up in the same place as many other companies, why not take the shortcut there? Culture is set in the early days and reinforced over time. Setting a no-titles culture created the collaborative nature of the BloomReacher. Even as titling is introduced, the value system has become so ingrained that it cannot be broken. The conservative approach to titles also ensures that we had the minimum amount of hierarchy needed for a given stage.

The spirit of the “no-titles” organization remains intact today and it is at the heart of everything we do that makes BloomReach healthy– debate, contribution, impact and limited politics. People said it would break over time as the company scaled. We are at 210 people and counting — and I’m still waiting.

Image from Ceramic Hierarchy by Travis licensed under CC by 2.0

The Perfect Board Meeting

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The board meeting needs re-imagination. At most companies, board meetings are either a source of angst for entrepreneurs and investors alike or a source of boredom for those who sit through hours of administrative minutiae. They are either too eventful or not eventful enough. Board meetings are an important communication vehicle and an important force in galvanizing the founders and the management team to step back and evaluate the business from the outside-in.

The perfect board meeting is a problem-solving session. It is a place where smart people with the “inside view” (the management & founders) and people with the “outside view” (investors and independent board members) can come together to solve the thorniest problems in a positive manner.

But lets start with the worst kinds of board meetings:

  • “Peacock” board meetings: The peacock board meetings are spent with each individual around the table showing off. Investors may show-off how much pattern matching capability they have. They may be positioning against each other. Management shows off what an amazing job they’ve done. Neither party has a conversation, and the parties leave keeping a mental score of who won. Peacock board meetings are not only counter-productive, they set up the kind of adversarial relationships that are ultimately destructive.
  • “Show your work” board meetings: In the “show your work” board meetings, every member of the management team comes through and fires up their powerpoint presentation. By the end of the session, everyone is bored and it feels like Physics 101 in a lecture hall of 500 people. No one gets anything out of the exercise and reading the textbook would have been just fine. In these meetings, everyone leaves with a lot of data, but very few people leave with any wisdom.
  • “Administrative” board meetings: Many public boards have become largely administrative – focused on stock compensation plans and auditing guidelines. The boards no longer focus on the key strategic issues of the time. Instead they are focused on liability-protection and ensuring that the company doesn’t screw up, not concentrating on what it takes to enable the company to succeed.
  • “Beat-down” board meetings: In the beat-down board meetings, members spend their time beating on the team. It becomes a venting exercise for the investors and an exercise in spin for the management. Beat-down board meetings destroy trust and ultimately cause decisions to be made for political reasons rather than value-creation reasons.
  • “Tangent” board meetings: Tangent board meetings involve one or more board members hijacking the agenda to discuss a tangent. Often that tangent involves discussing something largely peripheral to the prospects of the business for really long periods of time. Tangent board meetings cause others in the room to check out and represent a terrible waste of time.

So lets get to the perfect board meeting – a meeting between equals, engaged in helping solve the most important issues of the day. The meeting may start with minutes and resolution approvals, but it moves on quickly from there. Next up is a reminder of what was discussed previously, how that ties into today’s agenda and what key decisions have been made by the company. Remember, board members are busy and on a lot of boards. It’s your job to remind them what was discussed and agreed upon. The key performance indicators and operating highlights are discussed – but not in a lot of detail, because they can be sent out in advance. It is important, however, that you not assume that every board member has read all of your material in advance. They likely haven’t; and a common baseline is needed to have a valuable strategic conversation. If you’re spending more than half your Board Meeting baselining, however, that’s too much.

Board members will typically care a lot about sales metrics, revenues, the executive team and financing. You’ll feel like you’re spending a disproportionate amount of time on those topics versus other things that you may care equally about (like product, engineering, culture or marketing programs). Get used to it. Your board meetings are not intended to be balanced portrayals of your mental space. The core of the board meeting should be centered on key strategic questions that you are struggling with: Which market to go after? When to raise money? What are the critical hires to make? How to deal with a macro threat? These are tough questions to discuss with a team of people who are not thinking about them every day the way you are. You will feel like you’re doing a lot of education. That’s OK. If you tee up the discussion well, you’ll get a forest-from-the-trees perspective from a number of the people in your boardroom. They will ask you questions that make you re-evaluate your priorities and your intuition. The best board members will not tell you what to do. But they will offer strong opinions. It’s your job to consolidate those points of view, arrive at a decision and ultimately communicate it back to them (except for the small number of things that actually require a board vote).

The best board meetings are passionate, respectful and inclusive. They are open to the key leaders in the company. They allow for disagreement without personal attacks. The best board meetings are also stage specific. I remember our first board meeting 6 years ago with Ajay Agarwal from Bain Capital Ventures. It was entirely focused on hiring engineers. We’ve since had board meetings focused on people and culture, or financing strategy or go-to-market productivity metrics or strategic priorities or vertical expansion. The topics have to reflect where you are as a business. The best board meetings are continuations of conversations – ideally, you’re speaking to your board members with enough regularity (typically more in the early life of a company than later) that they are not re-learning the business every time.

The best board meetings are brutally honest about the challenges the company faces – typically surfaced by the founders/management and not the investors. The best board meetings keep to the agenda and avoid the many rat-holes. The best board meetings have some amount of cheerleading built into them. Company-building is a marathon and every good marathoner needs cheering along the race. The cheerleading helps the investors stay positive through difficult times and more importantly, it will help you and your team feel like you are all on a special journey. The best board meetings are forcing functions for internal communication and re-evaluation.The process of identifying important topics and preparing materials should cause you to keep perspective on the company’s priorities in the middle of the inevitable operational fires. And they provide an opportunity to reflect those priorities back to your larger team during all-hands meetings or through other company communication vehicles.

By no means has every board meeting we’ve conducted at BloomReach been perfect. I can remember plenty where we were guilty of the “show your work” Board meetings. But we’ve gotten a lot better.

And it goes without saying that the prerequisite to the perfect board meeting is perfect board members. Pick wisely and the rest is learnable.


Image from Board Meeting- Franklin Canyon by tiarescott licensed under CC by 2.0

10 Steps to make sure you next Board Member doesn’t Destroy Value

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As part of my work with Founder Collective and angel investing in general, I often get calls from entrepreneurs asking “who should I take money from.”  It’s a fairly innocuous question but one that most entrepreneurs get pretty wrong.  The usual criteria for venture-capital-firm selection (and the likely addition of an external board member) goes something like this:

  1. Maximize valuation.
  2. Maximize valuation from as good a brand name firm as possible.
  3. Maximize valuation from as good a brand name firm as possible and make sure that the selected firm/partner adds value to your business.

The problem: those are the wrong priorities.  The No. 1 criteria for the selection of your next investor and/or board member should be: can I answer (with 100% confidence) that my new partner will not destroy value in the firm I created.  Here’s why the question makes sense:

The success or failure of your entrepreneurial venture pretty much comes down to you and your team.  If you succeed, it’s because you and the team nailed it. Maybe the failure was the result of your own screw-ups.  Maybe it was driven by macro events.  Either way, it comes down to you.  On the other hand, investor impact on your venture is highly asymmetric.  If you succeed, your investors may have added some value, but its highly unlikely that the value they added was even close to being among the top five contributors to your success.  Of course, their capital was helpful and important, but in a world of capital abundance for good companies, it likely wasn’t their capital that made the difference.  On the other hand, investors can absolutely screw up your company.  They can lose faith in it during bad times and in the tight VC community, that perspective can get picked up by potential future investors – accelerating your demise.  Investors can force an exit for reasons that are driven by personal considerations (like wanting to put a “win” on the board), even when that may be at odds with maximizing the longer term potential of your firm.  They can create politics and become high maintenance board members – distracting you from core execution. I have seen board members bail on their founders, or recapitalize the company in their favor, or side with one part of the team over the other, or fail to approve routine investments and paralyze execution. The horror stories are many.

And yet there is nothing fundamental you can really do to protect yourself legally. Once your potential investor is a major shareholder, they have the ability to do enormous damage within the confines of even the most iron-clad shareholder agreement.  Which brings me to the golden rule of board member selection: validate that you can totally trust your next board member – even in the most difficult of circumstances.  First make sure there is no chance they destroy value; then optimize for price, brand and value-creation.

How do you validate that you can trust your next board member if you weren’t college buddies or business colleagues with them? Here are 10 steps to ensure your next Board Member will not destroy value:

1.  Don’t run a shotgun investment process.  Get to know potential investors before you ask them for money.  And just as they will likely disqualify you if they believe you’re not the right leader or team, disqualify them if you feel like you’re not on the same wavelength.  Do it pre-fundraising; when you’re not in the heat of the deal.
2.  Ask your angel investors who they trust. They’ve likely seen many more deals than you have and they have a vested interest in protecting their investment.
3.  Talk to other entrepreneurs who have taken money from your potential investors (ask them for references of companies where things went badly). Entrepreneurs can be pretty candid with other entrepreneurs.
4.  If you can, err on the side of investors who have proven themselves.  Minimize discussions with associates or principals.  Much of the “bad behavior” comes from individuals within the firm that don’t fundamentally have career security or partnership pull.
5.  Think about how your potential board member conducts himself or herself during the investment process. Are they overbearing? Are they largely unengaged? Is the due diligence painful or are their questions genuinely good ones? Are they transparent?  Do they seem open to your perspective or rigid in applying their pattern-matching experience?
6.  Invite them to meet your team and ask your team members what they think – often the team can see the bigger picture because they have not participated in 15 investment pitches.
7.  Stick to reputable firms if you can – you always want to take money from people who worry as much about their reputation as you worry about yours.
8.  Meet your future board member over dinner or a drink outside the confines of their office or yours.  Do you find yourself having to “spin” as you talk to them (bad sign) or can you imagine them being your first call when the going gets tough (good sign)?
9.  Don’t get bullied into artificial timelines. No reasonable investor that wants a 10x return walks away from a term sheet because of an artificial deadline. Take your time and do your diligence.
10.  Trust your spidey sense. Pay attention to the small things. Are they throwing in last minute diligence items late in the process? Are they introducing you to a new partner after they told you the partnership was on board? Are they displaying data analysis paralysis?  Are they failing to deliver on an intro they said they would make?

I have the good fortune of having an amazing group of investors and board members at BloomReach, from Bain Capital Ventures, Lightspeed Venture Partners and NEA.  In addition to not being value destroyers, they are tremendous value creators – they’ve helped with recruiting, thinking through strategic forks in the road, customer introductions, challenging our thought process and picking us up when times are tough.  I can count on them for crisp advice and yet also count on them to trust us to steer the ship.  I wish that kind of partnership on all of you.

Image from explosion by Talid Khatib licensed under CC by 2.0

How do you build switching costs into your business?

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I talked about whether network effects were overvalued in my last blog post. I talked a lot about the value of those network effects in increasing switching costs. Yet most of the examples I used were companies like Uber, Facebook and Microsoft. What about enterprise businesses? Many of the best enterprise businesses in the world have extraordinarily high switching costs, even without significant network effects. It goes without saying that any strong business needs to deliver significant value to retain customers, but beyond that, how do you go about building switching costs into your enterprise business? In this post, I will walk through five kinds of switching costs – Level 1 through Level 5.

Let’s start with why switching costs are important. They are about increasing the predictability and lifetime value of your customers. As you increase the switching costs, the lifetime value of your customers increase, and therefore your ability to invest in acquiring those customers at a higher cost increases with them – feeding the virtuous cycle of more customers, more revenue, more growth and more ability to drive growth. High switching costs are often (though not always) accompanied by high customer satisfaction. If your customers stay with you, their happiness will transfer over to help you sign more customers. If they are all switching out – prospects will question the value of your solution.

I believe there are multiple switching-costs levels:

Level 1 (“My lawyers will sue you if you leave me”): Level 1 companies build switching costs contractually – by signing multi-year contracts with onerous termination provisions. Many legacy software businesses and network providers sign multi-year agreements that prohibit them from switching away from the antiquated platform they have. Customers may not like the software – but the switching costs are so high that they stay. Level 1 switching costs don’t last – they just buy time until the contract expires; and they are increasingly hard to achieve in a SaaS world.

Level 2 (“I love you too much to switch.”): Emotional buy-in is definitely a form of switching costs. Not many enterprise products have the kind of emotional tie-in with their users that Consumer businesses like Apple have, but there are some enterprise products that have the “love” factor. Tableau is one such example – the Tableau user base loves the empowering nature of data visualization. Adobe’s creative suite products elicit similar responses. Graphic designers and other creative artists swear by the suite. You know you have a L2 business when your value proposition doesn’t require an analytical frame of mind to justify your product’s purchase. People buy it because they love it.

Level 3 (“My data and/or business logic is in your systems.”): Salesforce has Level 3 switching costs. The functionality of Salesforce CRM might be good, but even if someone else came along with a better product, the data investment that most companies have made to make Salesforce their customer data “system of record” is significant. Amazon Web Services has a similar story — having caused businesses to leverage Amazon as the data store for their applications makes it painful to switch. Replicating and migrating the data is possible, but just not worth it unless the service is really subpar.

Level 4 (“Your business depends on my business.”): Google might be the best example of this. Advertisers don’t have to love Google to stay with Google. For many of them, their business depends on Google. No CMO wants to show up with plummeting revenues because they turned off 20% of their customer acquisition, even if a marketplace (along with decisions Google makes) sets the price of their relationship. Oracle’s database business or SAP’s ERP business are a different form of “dependency.” Many of the world’s largest businesses run their entire operations on Oracle and/or SAP. Sure, they could switch if a better solution comes along, but the business disruption and the personal career risk would be so large that the threshold for switching is extremely high.

Level 5 (“You are my platform.”): The word platform might be the single most misused phrase in technology. There are, however, true platform businesses that enterprises build enormous amounts of business process and application logic on top of. Platforms may add value because of the network of applications that are built on them (that then add value to new applications) or because the key competitive advantages of the enterprise are tied into the platform they are on. Intel is a prominent example of such a platform. When a server manufacturer decides to build on the Intel architecture, you can assume that switching chipsets isn’t happening anytime soon. The distinction between L5 and L4 is subtle. In L4, my business depends on your business. In L5, my business and your business are so intertwined that the two have become indistinguishable.

So how should a startup think about these various kinds of switching costs? First, by caring about them. Too many startups are too focused on customer adoption, and too unfocused on switching costs. That’s just deferred and increased pain. Often the software that’s easiest to adopt, is also easiest to throw out. It might be worth having a product that has a longer sales cycle to materially increase switching costs. Second, the vast majority of startups aspire to get to Level 1-2, and rarely think through a path to achieve L3-5. Often, the longer one waits, the harder it can get to achieve that path. Finally, the key thing to remember about building switching costs is– if it makes sense for a customer to switch, they will switch. Obvious, right? Too many entrepreneurs and executives are too steeped in their own Kool-Aid to put themselves in the customer’s shoes and ask themselves the hard question: Is my product really worth it?


Image from old light switch by Paul Cross licensed under CC by 2.0

Are Network Effects Overvalued?

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“In economics and business, a network effect (also called network externality or demand-side economies of scale) is the effect that one user of a good or service has on the value of that product to other people.”

-Wikipedia

Network effects have always been the utopian goal of any technology business. Unlike the typical case of diminishing economies of scale – where the cost of acquiring the marginal customer increases as you saturate the early majority of your market – network effects create increasing economies of scale. The incremental user will often pay for access to a bigger network –so margins actually can improve as user bases grow. Network effect “lore” has become the dominant paradigm for start-up building in Silicon Valley.

Everyone knows the story of Facebook vs. MySpace. MySpace had a much larger user base but Facebook focused on the “Social Graph” (and a much better product) and ultimately dominated the network. Paypal followed the precedent of Visa and Mastercard and acquired tons of merchants, believing in the network effects of more merchants leading to more users leading to more merchants leading to more revenue. Most recently, Uber has raised $1.4 billion of capital on the belief that it needs to grow its user base, provider base and served cities to have the largest two-sided marketplace around – on the assumption that the network effects this creates will ultimately create world dominance. eBay understood this very well – optimizing for maximizing the number and diversity of listings and buyers and ultimately dominating the auctions market. Microsoft did it by building the Windows platform and acquiring both developers and users on the platform – crushing Apple in the early years.

The recipe seems simple right?

  1. Find a possible two-sided market.
  2. Invest aggressively to create early supply and demand.
  3. Identify what it would take to have hundreds of millions of consumers, suppliers or other value-creators enter the marketplace.
  4. Raise insane amounts of money to be able to acquire those hundreds of millions of market participants.
  5. Let your network effects turn you into the monopoly that you deserve to be.

Interestingly – the desire to create “network effect” oriented businesses has particularly accelerated as the costs of distribution on the Internet have decreased. It now seems possible (particularly given that capital availability has increased) to actually acquire hundreds of millions of market participants in a way that seemed impossible previously.

But what if those network effects are just fundamentally overvalued? What if the same factors that make it possible to build a network effect, also make it possible to break a network effect?

The core assumption underlying network effects is that switching costs for market participants grow as the size of the network increases. It’s hard for a user to switch their windows laptop for a Mac, because all of the applications they love were written for Windows. One can’t get off the iPhone because all of your devices, music and videos were built for it. It’s hard to get off Facebook, because all of your friends are on it. But maybe those switching costs are fundamentally overvalued – and that actually, its just as easy to get large numbers of users to switch to a new service (even for a network-effect driven business) as it was to acquire them.

Ultimately, users had no trouble switching from Windows to Macs – when Macs became clearly better. And while iPhones had the early lead in the smartphone category – Android has 62% market share versus Apple iOS which has 38%. And empirically – if the Facebook network effects were that strong and switching costs were that high – why would Facebook have paid $20 billion for WhatsApp and $1 billion for Instagram? Why did anyone even start using WhatsApp or Instagram, if the network effects were really that strong? Sure, the use cases and core users of those services might have been different from Facebook but they are adjacent enough that plenty of people would have suggested that the network effects of Facebook would carry it into those use cases much more naturally than a new start-up could emerge.

Switching costs (even for well formed networks) are just fundamentally weaker in the Internet age. While networks of developers, users, friends or merchants might provide substantial initial value, they can ultimately be defeated by a much better product. Pre-Internet, it would have been impossible for an amazing new product to get sufficient distribution to defeat a large network-driven competitor. Today, that new product has substantial access to capital and several billion Internet users that it can reach without ever opening a second office.

Lets do a thought experiment on Uber – today’s infallible star. The theory is that Uber has already dominated the transportation industry, building an amazing network of drivers and users so that no one will ever beat them. But don’t bet against innovation. What if I developed the following strategy? I decided to build the world’s best car service for the city of San Francisco? I provided self-driving cars so that I didn’t need to worry about their network of drivers and had a dramatically reduced cost structure. I had amazing service in my cars (super nice food, drinks, seats). I made the GPS actually work to a level of precision that Uber didn’t. I made the app even slicker and created a loyalty program of my own. I raised enough capital so that I had a sufficient number of cars and an even shorter wait time than Uber. I donated some of my Company’s proceeds to San Francisco charities to foster local buy-in. I focused my marketing maniacally on the communities of people who take cars most often– just in San Francisco. Suppose it was just a much better product for the San Francisco market? What would the switching costs be for a user to download Raj’s Car Service app versus Uber? Would that user be unwilling to do so because Uber has hundreds of millions of users or a large base of drivers?

The ultimate kryptonite for a network-based business is having a better product in an adjacent, but bigger market. Lets take eBay and Amazon. In 2001, as the Internet bubble died a temporary death – Amazon was supposed to be dead and eBay was the clear winner. They were the ones with the network effects from auctions (and no inventory costs). Fast forward to 2014, and Amazon is worth twice as much as eBay. Amazon had the kryptonite. They had a better product (more selection, fixed prices, great fulfillment, great customer service), in an adjacent market (e-commerce) that was so much bigger than the auctions market. Kryptonite.

The quest to build competitive advantage, economies of scale and switching costs is a worthy goal for all of us in technology. But beware the next time someone pitches you an idea on “the Uber of pets.” Ask them why they are trying to build that network? And beware of the trap of investing massively in building the two-sided network – only to have it marginalized by someone with a better product.


Image from network by Simon Cockell licensed under CC by 2.0

Your Office Space is Who You Are

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“Be yourself; everyone else is already taken.”

                                            – Oscar Wilde

Shortly after I graduated from college at Princeton I went to interview at Morgan Stanley in New York City.  Outside Morgan’s Times Square building, I saw the financial firm’s big neon sign – right next to a giant stock ticker and a few flashy ads for sitcoms.  As I walked into the opulent lobby, I found myself getting progressively more uncomfortable.  It took me a really long time to get through security and as I went through it – I felt like I was dealing with a bouncer at a nightclub.  The elevators on the way up were packed. As I walked into the conference room for my interview I looked around.  There were a number of pods with exhausted-looking analysts in cheap suits surrounded by super well-groomed partners working in oak-adorned offices that had soundproof doors – everybody in his or her (rarely) own place.  The conference rooms were decorated with huge glass mementos of a financing event or an M&A event.  They call the mementos “deal tombstones,” appropriate because no one there cared about the prospects of those companies once the deals were closed.  I got the offer, I didn’t want to work there.  I reflected on why that was – it was the office space. It wasn’t who I was.  Too opulent.  Too overstated.  Too hierarchical.  Too contrived.  Too formal.

In a world of increasing virtual communications, ironically, your office space is as important as it ever was.  It represents everything about you – your values, your relationships with people, the kind of people you want to recruit and the priorities you have.  It merits careful design.  We’ve gone through five offices at BloomReach – the first in Palo Alto at the Plug & Play and the next four in downtown Mountain View, culminating with our headquarters at 82 Pioneer Way.

Our office represents who we are – it’s open, reflecting our belief in open communication; its got BloomReach branding in its colors and its lobbies; it has a technology flavor to it with the Web Relevance Engine pictorial on the wall. It has a lot of individualism, reflecting the heterogeneity of the team. Teams and executives are interspersed reflecting the “we” orientation of our culture.  We designed it with the values we believe in: We believe that everyone needs to have a stake in the culture and therefore we created teams to decorate all of the conference rooms and their unique creativity is reflected in the spirit of each one.

We have the requisite foosball tables, ping-pong tables, recreation room, the famous BloomReach painting – and we have mementos charting our young history.  We have the anniversary wall, recognizing the many people who have grown up at BloomReach. The lunch room is bright and well integrated into the rest of the office – providing a place for people to meet up for casual conversations.  The conference rooms are named consistent with our “Get Found” motto.  White boards throughout are intended to encourage our “think” value.  The global clocks represent the global nature of our business.  Basically, the layout, design and decor reflects who we are.  I can see each of our cultural values – “truth”, “we”, “think”, “own” and “no drama” reflected in the office someplace – all without explicitly planning to do so.

On a New Year’s Day two years ago, I walked into our office to see that low-height cubes had been put up.  The idea was to provide more power outlets and more private workspace.  I don’t usually veto things but I exercised my veto on that New Years Day.  Productivity matters, but I felt that energy and openness mattered more.

All great companies have iconic office environments. Facebook just feels like a “move fast and break things” place.  Morgan Stanley was likely designed with the value system that made it one of the white shoe firms on Wall Street.  Victoria Secret has beautiful models on the walls. Urban Outfitters has the cool chic vibe that you’d expect from a company based at the Philadelphia Naval Yard.

Why do office environments matter so much?  They are a scalable representation of your values. You can’t speak to every member of the team personally, but the vibe of the office that your team walks into sends a message to everyone.  I’ve had candidates appear either super excited or super nervous walking into BloomReach. The office space helps with self-selection of those candidates. It also reflects the tradeoffs you care about.  Office spaces are a pretty good indication of whether the Company you’re interviewing with or selling to is a good choice for you.  I had one sales leader tell me “we shouldn’t sell to Companies that serve coffee in styrofoam cups – they probably can’t afford our software.”  That is a pretty good qualification criteria.


The diversity of office space in Silicon Valley is telling. You have everything from the big campuses at Cisco and Oracle and Google, to the non-descript systems startups with tall cubicles, to the uber-chic urban offices in San Francisco.  Walking into those offices – you see the value system of the founders and the leaders.  Designing the identity of your office should not require more money – in fact if you’re hiring branding consultants to design it, it is by definition not who you are.  There is no wrong answer in designing it – just make it authentic.

Leaders should be Problems Solvers and Problem Creators

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The trajectory of most careers starts with problem solving.  Good engineers, faced with a well-defined problem, can usually do an effective job thinking through how to best solve the problem.  The best engineers find the 10x solution – 10x more scalable, 10x more maintainable in one-tenth the time. Good marketing people, armed with an adequate budget and clear goals, problem-solve around messaging or marketing program choices.  Good finance people take the characteristics of the business and think about the best deployment of capital to achieve the desired outcomes. Good salespeople are problem-solving around how to navigate obstacles to persuade decision-makers.  We all start our careers honing skills around being effective problem solvers.  I spent the early part of my career problem-solving as an engineer, problem solving as a financial analyst and problem solving as an early entrepreneur.  And some of the best individual contributors at BloomReach, and at every organization I’ve seen, are incredible problem solvers.  The CEO job involves a ton of problem solving.  And usually, by the time the problem reaches you, it’s a big hairball.  It’s a decision where the path is unclear and where the data is murky (a bet on a new market or new product). It’s a complex, people-oriented problem (a manager or team not performing or two leaders not getting along).  Or it is a problem that has inherent short-term vs. long-term trade-offs (losing a customer that might be very valuable vs retaining that customer at the cost of longer-term priorities).

 

Great problem solvers who continue to advance in their careers, are constantly broadening the scope of the problems they can take on.  At any startup, leadership opportunities often outpace the people that the startup has to take on tough, large-scope problems. As I look at the people who have advanced quickly at BloomReach we’ve seen them grow from task-oriented problem solvers to outcome-oriented problem solvers.  On the customer-success side, they move from “I can complete the analysis” to “I will own the customer’s success end-to-end.”  On our engineering team, they move from “I can build this component” to “I can lead this project.”  Being an outcome-oriented problem solver provides enormous benefit to one’s manager. There is nothing an oversubscribed manager appreciates more (or should) than someone on the team who says “I got this.”  And has the credibility to have earned that trust.

 

Being a great outcome-oriented problem solver is a necessary, but not sufficient, condition for true leadership.  Leadership means both being a problem solver and a problem creator.  The inherent nature of a well-executing team is that they are focused on solving a problem.  But what if the problem definition needs changing?  What if you have a team chasing a revenue goal when they should be chasing a customer satisfaction goal?  What if you are executing really effectively against a narrowing addressable market?  What if your organizational alignment inherently is misaligned with the goals of the company?  Those are all times to step in and create problems for the teams involved.

Problem creation has been important at BloomReach.  At times, we’ve created problems to  drive a change of direction – sometimes by hiring a new exec, sometimes by personally selling a customer who might be outside of the qualification criteria, sometimes by reorganizing a team, sometimes by radically changing the product goals and sometimes by materially changing budget allocations.  Many of these steps create more problems (at least in the near-term) than they solve.  Often, they materially disrupt the execution cadence of the organization.  They invite significant dissent among key team members.  But they are key to driving a team or an organization to raise the bar, think differently and adapt to a dynamic world.  I’ve seen cases of leaders going down the problem creation road too far.  They create so many problems that they set their teams up for failure.  They are unsympathetic when a team member asks for help.  They become unapproachable.

 

Many of the best leaders are great problem creators, inspiring teams to achieve what they never thought possible and adapt in ways that can appear radical at first, but become second nature over time.  And they are also great problem solvers, taking ownership for the toughest problems around and helping teams navigate them. The problem-creation gene is a wholly different gene than the problem-solving gene.  Problem solvers want to get through the task list.  Problem creators want to create a new one.  The best leaders get both genes to co-exist in harmony, artfully drawing on each at just the right time.

Image from Troublemakers by THEJOKER licensed under CC by 2.0

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