The customer is always right

One of my most vivd memories of our first major software development contract, to support HP’s first color printer for the Macintosh, came with celebratory banquet. We all got little plaques, and mine said: “Keep ’em happy.” (I still have that plaque in my closet.)

To the customer, this was probably a good thing. However, the slogan (volunteered by a subordinate) reflected a tension in our 18-month-old company — between the marketing slime (me) and the engineers (everyone else) over how far we were willing to bend to keep the customer happy.

The reality is that for a small, young and underfunded (particularly self-funded) company, revenue is everything: you won’t keep the doors open without it, and it’s only going to come from one place: the customer.

When we founded the company in 1987, I’d never taken any business classes. However, as the only one who fully understood our financially precarious position (not a good idea), quickly worked to implement the old maxim: the customer is always right. (Admittedly, where possible I would say “you're right, it needs that feature, but that’s not part of this version: let’s put it in the next version that you buy.”)

If you’re venture funded, you have a different imperative: grow fast or die trying. Sometimes that means getting early customer wins, but in other cases it means building as complete a product as quickly as possible — without regards to initial feedback — to have something that will be best-in-class and pre-empt the inevitable competitors.

Apparently, if you are a centimillionaire with an ambition and ego that is out of this world, even these rules don’t apply. How else can one explain the quixotic attacks by Tesla CEO and co-founder Elon Musk on the New York Times, who had the nerve (the nerve!) to publish an article last week describing a long-distance test drive gone horribly wrong. All week, he has been mounting a jeremiad against the newspaper and its reporter, accusing them of lying, lack of ethics, falsifying and just about everything short of kicking a dog and abusing children.

Perhaps — as with a political candidate — he’s trying to dispel any doubts in his base, rather any attempt to appeal to the average buyer. Still, it seems to be a counterproductive strategy; as Nicholas Thompson, a New Yorker editor wrote today:

It seems there are a few things we can learn from this:

• Never escalate a fight about a negative review, unless you're certain to win. The debate has driven a lot of people to Broder's initial review. And there's nothing in that review, or the rest of the debate, that's going to make anyone want a Tesla car.
• Twitter is a temptation. Musk's fierce initial response is artful. The first sentence is clipped and sharp. But, even when he first put it out, did he think that "fake" was the perfect word? Or was it just that it's shorter than, say, "flawed"?
• If your company has a celebrity CEO, use him carefully. Musk has a lot of power, in part because of his position of social media. But by personalizing this battle, he's done real harm to both his brand's and to Tesla's.

But then Musk has a habit of shooting the messenger, exaggerating and even lying in his attacks on reporters who disagree with him. A VentureBeat reporter wrote nearly three years ago:

I don’t believe Musk twists the truth out of malice. Rather, at this point, it may well be out of habit. He’s so used to getting his way that future possibilities just seem like present realities to him. And pragmatically, it’s worked. Whenever Tesla has been in a bind, Musk has spun his way out of trouble.

It’s a character trait of which elements are found among many successful entrepreneurs: the compelling presentation of an alternate reality in the hopes that so many people will sign on to the vision that it comes true. Apple CEO Steve Jobs, for example, is so masterful at this that people speak of his reality distortion field. But Musk may have taken distortion to extremes.

The old Steve Jobs (Jobs I) was like that: a good friend went to work for Jobs (at NeXT) and told me that everything I’d heard about “reality distortion field” was true.

However, in the Jobs II era, Steve had grown up: it was all about surpassing all customer expectations. After firing (or dressing down) the person responsible for such a fiasco, he would have set his minions to work on fixing it. For the sake of the Tesla employees, let’s hope that (despite the bluster) that’s what California’s leading car company is doing.

Meanwhile, for us mere mortals without VC (or personal) millions and a celebrity reputation to save us, there’s only one choice: treat the customer right. Or else. That goes double for reviewers and other opinion leaders to whom our customers turn to for advice.

Zipcar: it's hard to create a stand-alone business

Zipcar sold itself Wednesday to Avis for a half a billion dollars. While that's a hefty premium over final close last week, Dennis Berman of the Wall Street Journal notes that it’s only about half of what the company was worth two years ago at its IPO. The company has $55 million in cumulative losses, but was unable to cost-effectively acquire new customers.

With its greater scale, scope and buying power, Avis hopes to succeed where Zipcar failed. Avis-Budget-Zipcar will be competing with the two other major rental car conglomerates, Hertz-Dollar-Thrifty and Enterprise-National-Alamo-Vanguard-Tilden.

In other words, while Zipcar invented a new business model, it didn’t invent a new industry. It was a failure for public investors and as a stand-alone company. Even several of its venture investors — whether seeking a bigger pop or perhaps having some shred of ethics — hung in with the public investors, hoping for a turnaround that never came.

I think this is symptomatic of a larger problem, which is the difficulty in creating new stand-alone companies that will last. Facebook (and Amazon and Google) will survive, but will LinkedIn and Twitter and Yahoo?

Dan Henninger in the WSJ this morning suggests that the hostile business climate of the past four years is contributing to the problem, but my sense is that it’s hurting low margin businesses — ones that have little margin to spare when faced with higher taxes or regulation. I suspect that the high margin home-run companies work whether the top personal and Subchapter S marginal tax rate is 35% of 2012, 41% in 2013 or 54% now in California).

Instead, I think the issue is whether firms can create new industries, like personal computers, networking, e-commerce, Internet services, social media, biotechnology and the like. The PC and Internet services seemed to catch the incumbents sleeping, and the nature of the e-commerce transformation is overwhelming the incumbent industry more quickly than it could have imagined.

However, Google is meeting the social media challenge more quickly and vigorously than most incumbents. Meanwhile, the long lead times (and huge risks and capital requirements) of the pharma industry have made it difficult for new biotechnology companies to enter without competing with existing biotech or finding Big Pharma is now demanding a high price for access to its channel.

Overall, exit by acquisition rather than IPO is the norm — one more data point that the go-go 1990s were an aberration. Even for companies that do IPO, many of them (like Zipcar) will find their real growth in the bowels of a large, bureaucratic, cash-flow positive enterprise.

When entrepreneurs aren't "the next Apple"

Big company exec-turned-Forbest columnist Steve Faktor posted a funny column Friday that says “Shut Up, You’re Not Apple”.

The introduction is as provocative as the title:

At first, it was funny to hear insurers, IT firms, and startups with no revenues compare themselves to Apple. Since the iPod launched in 2001, I’ve seen hundreds of presentations that liberally use “learnings” from Apple. 1) The word is LESSONS, not “learnings”, my Hillbilly friend. 2) The comparison feels as fresh as that Michael Jackson impression your spouse has been doing since you started dating. 3) Drenching slides (or products) in an iconic brand’s juices won’t transmit innovation, like some benevolent plague. If that were possible, we’d never stop harvesting and packaging Brangelina extract. It’s time for an intervention. Here’s why brands must find their own voice (and scent)…and keep those synthetic Apple fumes from turning into laughing gas.

The ‘why you’re not Apple’ checklist:

I know I’m not alone. We’ve all been to the same Apple-laden meetings…er, orchards. How did those comparisons work out? Did that company become the most valuable in the world? Did that product become iconic and emulated by every company in Korea? Or, did it live and die in its sad PowerPoint tomb.

Using Apple as a model is the business version of ordering jeans after seeing them on Kate Upton. They might not look the same on you. Like Kate, Apple is a unicorn. It defies so many conventions that deconstructing its lessons is silly, unless it’s the last thing between you and a lonely Saturday night at Harvard Business School. To quote my friend and fellow innovator Stephen Shapiro’s book, Best Practices Are Stupid.

It’s not that your company can’t be Apple. It’s that your company absolutely, positively will never be Apple. I’m not discounting your skill or vision. I’m simply acknowledging that Apple’s success is a witch’s brew of leadership, timing, technology, and culture. All those variables can’t be replicated.

He then offers a checklist of factors that it would take to be Apple: a visionary CEO, iconic products, $50b in cash, a million fanboys, and #1 or #2 in most product categories. Yes you can mention Apple in your analysis of the industry landscape, but “as the unicorn in the room.”

As someone who’s studied Apple for almost 30 years, the reality is not just that Apple is one in a 100 million companies: it’s that Apple’s run from 2001 (the first iPod) to 2007 (the iPhone) to 2010 (the first iPad) — will never be repeated in the company’s history. (Or as Faktor put it, “Even Apple won’t be Apple forever.”)

I remember when Neil and I started our company in 1987, we wanted to be the next Hewlett-Packard. Instead, we never got more than 15 employees, a few million in revenues and lasted only 17 1/2 years. Wanting (or posing or emulating) doesn’t bring success: satisfying some need better than anyone else — in a way that’s hard to copy — is what bring success.

When they started in a Los Altos garage in 1975, Steve Jobs and Steve Wozniak didn’t imagine they would have a market cap bigger than IBM. Instead, they were just trying to bring a better PC to market than any of the other hobbyist-hackers out there. Customers didn’t flock to the Apple II, Mac, iPod, iPhone or iPad because Apple wanted to change the world, but because they had a product that no one else had.

Foolish MBA student business plans

One nice thing about teaching entrepreneurship at an independent technological university (like KGI) is the possibility of having actual science in our startup business plans. Tech startups may not create all of the shareholder value, economic growth or improved societal welfare, but certainly they play a disproportionate role in doing so.

The challenge of teaching entrepreneurship (particularly business plans) in a business school is (politely) sifting through all the restaurant, bar, website or other service businesses that are unlikely to amount to a hill of beans. Maybe the business plans of science and engineering students are equally likely to fail, but the potential payoffs are higher and they’re more likely to learn something relevant in the process.

I was reminded of this when reading a HBS case† from my intro entrepreneurship class. The case centers on four Harvard MBA students who want to start a business. So they spent a year sifting opportunities through six criteria, which included these quintessential MBA student goals:

• “Be their own boss”
• Invest a minimal amount of start-up capital
• Build a sustainable and defensible business

What’s wrong with this picture? I don’t know about the Harvard boys (and they were all male), but at least our KGI students take strategy in the first year and learn about something called “entry barriers”. (Perhaps the boys slept during Michael Porter’s class.)

This goes back to the fundamental problem of b-student business plans: anything a typical MBA student can start is something any fool can start. Meanwhile, science and engineering students are working on creating something that hasn’t been done before — one that hopefully has a lucrative commercial application.

So instead of dreaming about the perfect opportunity, the Harvard students would have been better off buying drinks down at the bars near MIT for smart technologists who actually have some secret sauce.

† Title omitted to protect the guilty.

VC is no panacea for startup success

One of the major messages taught in entrepreneurship classes is the importance of winning venture capital. Now research by a retired entrepreneur suggests it’s no panacea, according to a report last week in the Wall Street Journal:

About three-quarters of venture-backed firms in the U.S. don't return investors' capital, according to recent research by Shikhar Ghosh, a senior lecturer at Harvard Business School.

Compare that with the figures that venture capitalists toss around. The common rule of thumb is that of 10 start-ups, only three or four fail completely. Another three or four return the original investment, and one or two produce substantial returns.

The latter matches the famous Bob Zider article in HBR that we entrepreneurship faculty have all used at one point or another.

Based on Ghosh’s study of 2000+ firms that received VC from 2004-2010, approximately 30-40% end in liquidation with investors losing all their money. As Berkeley entrepreneurship scholar Toby Stuart notes, failure is even harder on those who bootstrapped their company using their own or family money (rather than drawing a salary at a VC-funded startup).

Of course, the risk/reward profiles are different between the venture and non-venture backed startups:

"People are embarrassed to talk about their failures, but the truth is that if you don't have a lot of failures, then you're just not doing it right, because that means that you're not investing in risky ventures," [said David Cowan of Bessemer Venture Partners]. "I believe failure is an option for entrepreneurs and if you don't believe that, then you can bang your head against the wall trying to make it work."

Overall, nonventure-backed companies fail more often than venture-backed companies in the first four years of existence, typically because they don't have the capital to keep going if the business model doesn't work, Harvard's Mr. Ghosh says. Venture-backed companies tend to fail following their fourth years--after investors stop injecting more capital, he says.

Of all companies, about 60% of start-ups survive to age three and roughly 35% survive to age 10, according to separate studies by the U.S. Bureau of Labor Statistics and the Ewing Marion Kauffman Foundation.

As the article alludes, there is a larger question of why the firm failed, which could include:

• VCs pulled the plug
• ran out of money
• entrepreneurs decided to fold their hand

These are often correlated, but it’s hard in a large-scale study to determine the direction of causality between them. In many cases, the best strategy is the fail fast and live to fight another day (particularly if you haven’t bankrupted yourself in the process).

Ghosh has a Harvard MBA, spent his earlier career as a partner at BCG and before becoming a serial entrepreneur founding a series of IT startups including Appex and Open Market. Alas, there’s no paper on his website to share the ful details of his study.

Chasing what is not yet known not to work

Today was one of the best events of the year for Bay Area cleantech entrepreneurs, with a panel discussion by three CEOs and one chairman of local biofuels companies (Amyris, Cobalt, Solazyme and LS9, respectively). I organized the event on behalf of the MIT Club of Northern California.

It was a great evening of very sharp leaders talking about how to make a successful business in a high-tech, high-risk industry based on biotech and chemical engineering. We had a standing room only sellout crowd, based in part on favorable publicity from the Merc and Biofuels Digest.

While we learned a lot from all the panelists, a unique perspective was offered by Noubar Afeyan, a Boston VC (and MIT alum) who appears to be a serial (perhaps chronic) entrepreneur. His Flagship Ventures web page says he’s “co-founded and helped build 24 successful life science and technology startups,” including roles building Applera and Celera in the biotech segment.

Afeyan is the chairman of three biofuels companies: LS9, Joule and Midori. The Bay Area’s LS9 was his firm’s 9th life science startup. As he said, “we number our companies the way that MIT numbers buildings.” (Inside joke for us MIT alumni: buildings, courses, majors are all given by numbers rather than names.)

In his opening slide, he showed an oft-quoted cartoon about the optimism of two archaeologists looking at a tiny pyramid in the desert, with the caption “This could be the discovery of the century. Depending, of course, on how far down it goes.”

This set up one of his best laugh lines of the evening, in which he said all the entrepreneurs in the industry were chasing “what is not yet known not to work.”

That seems to capture what makes high-tech entrepreneurship different: we don’t know what technologies will work and won’t work, so we invest in pursuing things that might work (or at least are not yet known to fail) in hopes of finding the one that does work. That seems almost the definition of entrepreneurial optimism: if it isn’t known to fail, it’s worth trying.

Sometimes the VCs are right

Regular readers of this blog know that I’m of two minds about VCs. There are some business opportunities (such as the biotech companies KGI alumni work for) that require venture investing. However, VCs often work contrary to the entrepreneurs’ interests — sometimes comically so.

At an algae (and biofuels) conference in San Diego last week, David Tze of the boutique private equity firm Oceanis talked about what he looks for in an investment. Some of it was specific to his fund’s focus (aquaculture, i.e. feeding farmed fish), but some of it was more generic.

In particular, he lifted (with full attribution) Sequoia Capital’s advice for entrepreneurs seeking funding for their business plans. The checklist for business plans matches what any entrepreneur might learn from a business plan class, but the “elements of sustainable companies” was a little more provocative:

Start-ups with these characteristics have the best chance of becoming enduring companies. We like to partner with start-ups that have:

Clarity of Purpose
Summarize the company's business on the back of a business card.

Large Markets
Address existing markets poised for rapid growth or change. A market on the path to a $1B potential allows for error and time for real margins to develop.

Rich Customers
Target customers who will move fast and pay a premium for a unique offering.

Focus
Customers will only buy a simple product with a singular value proposition.

Pain Killers
Pick the one thing that is of burning importance to the customer then delight them with a compelling solution.

Think Differently
Constantly challenge conventional wisdom. Take the contrarian route. Create novel solutions. Outwit the competition.

Team DNA
A company’s DNA is set in the first 90 days. All team members are the smartest or most clever in their domain. "A" level founders attract an "A" level team.

Agility
Stealth and speed will usually help beat-out large companies.

Frugality
Focus spending on what's critical. Spend only on the priorities and maximize profitability.

Inferno
Start with only a little money. It forces discipline and focus. A huge market with customers yearning for a product developed by great engineers requires very little firepower.

Of these, some are motherhood and apple (or Apple®) pie. The “frugality” and “inferno” seem ironic given the role of Sequoia (and other Sand Hill Road) VCs in fueling various bubbles over the years.

However, I think two points bear repeating — and I will repeat both in teaching my entrepreneurship class and advising would-be entrepreneurs. One is the “pain point” idea, now a part of the guidelines give for many opportunity pitch competitions.

Perhaps more interestingly — at least for tech entrepreneurs — is the idea of price-insensitive customers to buy the early expensive products until the firm learns how to make the products faster and cheaper. This is how computers, cellphones, Internet service got started, and my own research into telecom engineers shows the same effect. Since joining a biotech-oriented institute, I’ve also learned how life science companies have targeted expensive pain points, as when Genentech targeted the human insulin with its first product, Humulin.

So overall, I believe the experience of VCs can help nascent entrepreneurs prioritize their efforts — as long as they watch their wallet when it comes time for actual investments.