A Dozen Things I’ve Learned from Marissa Mayer about Business, Management, and Innovation

 

 

  1. “Technology companies live and die by talent. That’s why when people talk about the talent wars…when you see the best people migrating from one company to the next, it means that the next wave has started.” “Really in technology, it’s about the people, getting the best people, retaining them, nurturing a creative environment and helping to find a way to innovate.”  “I definitely think what drives technology companies is the people; because in a technology company it’s always about, what are you going to do next?” “It’s really wonderful to work in an environment with a lot of smart people.”  “I realized in all the cases where I was happy with the decision I made, there were two common threads: Surround myself with the smartest people who challenge you to think about things in new ways, and do something you are not ready to do so you can learn the most.” Among the most common themes in my series of posts is exactly what Marisa Mayer identifies in these quotes.  It is not possible to be successful in business without great people. Great people attract more great people in ways that are mutually reinforcing creating a positive feedback loop. Whether great people are arriving or departing is something a CEO must make a top priority. Marissa Mayer, through “talent acquisitions” and otherwise, has clearly been very focused on improving the talent base at Yahoo. Marissa Mayer understands that in a technology business, when a fire alarm goes off, the most important assets of the business leave the building. Lee Iacocca once astutely said: “I hire people brighter than me and I get out of their way.” Jack Welch has similarly said: “The essence of competitiveness is liberated when we make people believe that what they think and do is important – and then get out of their way while they do it.”

 

  1. “Every organization has a drawback. There are some companies that go back and forth between a functional and divisional organization.  In the end, it doesn’t matter. It’s important to know what those drawbacks are and work around them. But you shouldn’t spend too much time reorganizing.” Anyone who has worked at a big company has experienced reorganizations. The classic move in any reorganization is between a divisional organization and a functional organization.  Each organizational structure has certain benefits and drawbacks.  For example, in a divisional organization, each group within the company is responsible for its own each product(s) as well as its own profit-and-loss results. GE is often cited as a classic example of a divisional organization. Supporters of the divisional organization argue the structure creates clearer accountability for results and less dependencies on other groups.  If a functional structure is adopted, each group is organized by function(s). Supporters of a functional organization argue that the system prevents a “warring tribes” culture in which groups fail to cooperate. They also argue that when products must be tightly integrated, functional structure works more effectively. Motorola of 20 years ago is often cited as a company where a “warring tribes” culture was actually encouraged by management. Apple is often cited as an example of a company with a functional organization. Marissa Mayer isn’t saying don’t ever reorganize. What she is saying is that: (1) a CEO and their board should carefully chose a structure and not be jumping back and forth between functional and divisional choices and (2) once the structure is chosen, the CEO’s task is to exploit the strengths of the structure chosen and “work around” the weaknesses.

 

  1. “I don’t know a lot about genetics, but I understand some of it and I think that what you really want are the genes that are positive to hyper-express themselves in culture. Take the elements of fun, take the elements that are really motivating and inspiring people, and amplify them and ramp them up. And take some of the negative genes that are getting in the way and shut them off, and figure out what’s causing those and shut them off… When you’re coming into a company, and you know you have to do a transformation, what you really want to do is look at the company and say, ‘Okay, here are the parts that the company does well. How do we get those genes to hyper-express? The genes that are getting in the way, how do you turn those off?’” The importance of culture is another theme in this series of blog posts. Mayer’s analogy to genetics is a great one when thinking about culture. Culture is something that when done right is almost automatic, as is the expression of a gene. A culture that has gone off the tracks is a genuinely hard problem to solve.  Bill Gates said once that he admired what Lee Iacocca did at Chrysler since turning around a culture is such a very hard thing to do.  For the same reason Warren Buffett once said “turnarounds seldom turn” a CEO who wants to create cultural change must put a lot of effort into the process and deserves applause if they do it successfully.

 

  1. “The interesting thing about being CEO that’s really striking is that you have very few decisions that you need to make, and you need to make them absolutely perfectly. …you can delegate a lot of the decisions, but there are a few decisions, and sometimes it’s not obvious, that you need to really watch, and that can really influence the outcome. [As a CEO you must watch] for those decisions every day wondering to yourself, ‘Is this one of them or is this one where it doesn’t really matter what the decision ends up being?’” “Eric Schmitt would always say this very humbling thing that’s really true, which is that good executives confuse themselves when they convince themselves that they actually do things. He would say, look, it’s your job as leadership to be defense, not offense. The team decides we’re running in this direction and it’s your job to clear the path, get things out of the way, get the obstacles out of the way, make it fast to make decisions, and let them run as far and fast as you possibly can.” Marissa Mayer is making two important points here. The first relates to the importance of a CEO setting a direction by making a small number of pivotal decisions. The second relates to making sure that people have the freedom and resources necessary to get things done. Someone I really admire who has been a senior executive for decades puts it this way: “I think far too many people think ‘management decisions’ or ‘leadership = decisions’” – I agree. If the CEO is constantly dropping down into the organization and making decisions for people, processes inevitably bog down, the CEO inevitably makes many poor decisions since he or she is not close enough to the situation and the teams involved become dispirited and less confident since they are being second-guessed.

 

  1. “Product management really is the fusion between technology, what engineers do – and the business side.” Striking the right balance between “the business side” and “what engineers do” is a core function of the CEO. The focus of my own career has been on what Marissa Mayer calls “the business side.” But if everyone limits their scope to just one side, the business is going to have a huge problem. I’m a fan of this Mike Maples, Jr definition of a business model: “The way that a business converts innovation into economic value.” To make this happen you need strong talents on both the business and technology sides, but at least a few key people need to understand how to link the two sides. Call these people spanners or whatever, they perform a necessary and even critical function. As an example of Marissa Mayer understanding this need and taking action to create a class of people who can span the two sides, she was the founder of Google’s Associate Product Manager Program. Wired magazine wrote once about this innovative program as follows: “Google would hire computer science majors who just graduated or had been in the workplace fewer than 18 months. The ideal applicants must have technical talent, but not be total programming geeks — APMs had to have social finesse and business sense. Essentially they would be in-house entrepreneurs. They would undergo a multi-interview hiring process that made the Harvard admissions regimen look like community college. The chosen ones were thrown into deep water, heading real, important product teams ‘We give them way too much responsibility,’ Mayer once told me, ‘to see if they can handle it.’ ” This sort of cross disciplinary training is invaluable for both businesses and the individuals involved since the skills learned can help a company avoid “man with a hammer syndrome.” The best solutions always involve tools and approaches from multiple disciplines.

 

  1. “The beauty of experimenting … is that you never get too far from what the market wants. The market pulls you back.”  “If you launch things and iterate really quickly people forget about those mistakes and they have a lot of respect for how quickly you build the product up and make it better.” Innovation, not instant perfection. ..when we launch something people immediately say, “Well, it’s so rough it’s not very good”. …But the key is iteration. When you launch something, can you learn enough about the mistakes that you made and learn enough from your users that you ultimately iterate really quickly? I call this my Max and Madonna theory. We look at, like, Apple, Madonna. They were cool in 1983, they’re still cool today, 2006, 23 years later. And that’s really amazing to look at, and people think of them as very innovative and very inventive. How do they do it? And the answer is, they don’t do it being perfect every single time. You know, there’s lots of mess-ups along the way. Apple had the Newton, Madonna had The Sex Book. There’s been all kinds of controversies and mistakes made. But the answer is, when they make a mistake, you re-invent yourself. And I think that’s ultimately the charge that we have, is to launch these innovations and then make them better.” Marissa Mayer has a “New Product Development” class on Udemy.  The syllabus notes: “Marissa Mayer, Google’s Vice President of Search Products & User Experience, by which the company bases its decisions. Google’s approach is the take the guesswork out of product design, from functionality to shades of color, and they believe in the science of well-monitored and frequent A/B testing.” Marissa Mayer is talking in this set of quotes about the iteration process that that I wrote about in my post on Eric Ries and Lean Startup. In that post I explained that there are tradeoffs involved in a lean process, and the right choice depends on the nature of the business, the opportunity and how much cash is available. Applying the scientific method to business can reap big rewards. As an aside, readers of this blog know that I recently wrote a post on Bill Murray who starred in the greatest movie ever created on A/B testing: Groundhog Day.

 

  1. “When you can make a product simpler, more people will use it.” “When you see that notion in a product where you’re just like ‘wow this helps me do something I didn’t think I could do or helps me do something I didn’t think I could this easily; that’s the mark of a great consumer product.”  “I think a great product is something where you see an acute user need and you solve it in a way that is frictionless and beautiful. You really hope there’s an element of personality and delight there. But I do think it’s identifying the need and then finding an easy way to solve it. Sometimes you can solve it straight and head on….sometimes you solve it in an interesting way….sometimes it’s about innovation, sometimes it’s about coming at the product very much head on, but it’s really about having an eye for design and eye for the user need. How to not get in the users way. How can you just help someone immediately get something done especially if they’re doing something every day, multiple times per day, you really want it to be something that is easy and fast and simple with nothing in the way.” There is no doubt that what Marissa Mayer describes is hard. And that some people are better at this process than others. And that a very small number of people are savants in creating great products. And that some people create great products “once in a row.” I would also add that there are way more strikeouts than tape measure home runs in this process. And that the results are very often winner take all. It is tricky stuff. Most things fail. The products that do succeed, regardless of whether they were created by skill or luck, or a measure of both, move society forward.

 

  1. “You can’t have everything you want, but you can have the things that really matter to you.” “Innovation is born from the interaction between constraint and vision.” “People think of creativity as this sort of unbridled thing, but engineers thrive on constraints. They love to think their way out of that little box: ‘We know you said it was impossible, but we’re going to do this, this, and that to get us there.” “Constraints can actually speed development. For instance, we often can get a sense of just how good a new concept is if we only prototype for a single day or week. Or we’ll keep team size to three people or fewer. By limiting how long we work on something or how many people work on it, we limit our investment. In the case of the Toolbar beta, several key features (custom buttons, shared bookmarks) were tried out in under a week. In fact, during the brainstorming phase, we came up with about five times as many “key features.” Most were discarded after a week of prototyping. Since only 1 in every 5 to 10 ideas works out, the strategy of limiting the time we have to prove that an idea works allows us to try out more ideas, increasing our odds of success.” Many of my own formative years were spent in the wireless business. One things I learned in that business is that almost everything has tradeoffs, and that there are constraints everywhere. As an example, “Shannon’s law, which basically defines how much data can be sent over wireless links, considering the amount of spectrum, number of antennas, amount of interference, etc. To increase capacity could increase the amount of spectrum, or you could also increase the number of antennas, as done with MIMO (multiple input multiple output) or utilize small cells.” In my way of thinking, MIMO is a classic example of engineers facing the sort of constraint Marissa Mayer talks about (e.g., laws of physics are laws and not guidelines) and nevertheless innovating. As Sir Ernest Rutherford, the famous New Zealand physicist once said: “We haven’t got the money, so we’ve got to think!”

 

  1. “We believe that if we focus on the users, the money will come. In a truly virtual business, if you’re successful, you’ll be working at something that’s so necessary people will pay for it in subscription form. Or you’ll have so many users that advertisers will pay to sponsor the site.” “If you’re really successful and you get used a lot, there’s usually a very easy and obvious way to figure out how to monetize it.” This approach to business model creation is founded in optionality. I have written about optionality many times in this blog series. You want to find situation where an investment has a small potential upside and a massive potential upside. The optionality-based thesis in this case is: get unique users and data about those users, and the odds are excellent that a way can later be found to a profitable business model (or a sale of the company which needs to play defense). This process can work in a spectacular fashion but can also fail both in a spectacular way and in quiet obscurity. This business model development based on optionality process works best if the business  happens to have a moat. Extrapolating the Google experience to startups is not fully applicable or realistic, since Google owns the AdWords platform and startups can’t easily use new services as loss-leaders to feeder into something like that which has a moat.

 

 

  1. “There’s a myriad of different places that ideas come from, and what you really want to do is set up a system where people can feel like they can contribute to those ideas and that the best ideas rise to the top in sort of a Darwinistic way by proof of concept, a powerful prototype, by demonstrating that’s it’s going to fill a really important user need, and so on and so forth.” Marissa Mayer has worked hard to stamp out a “not invented here” mentality when it comes to ideas many times on her career. She believes systems to float new ideas and filters that enable truly worthy ideas to be acted upon are essential. This is particularly hard to do once a company reaches significant scale. Her Udemy class includes this description of her views on ideas: “Both the enterprise and the end users are better served by a culture that revolves around rewarding great ideas, rather than the self-promotion of getting others to acknowledge the contributions of an individual. Marissa Mayer… believes that if you fill a room with smart people and give them access to information, brilliant ideas will flourish, and the need for a strict management hierarchy dissolves. A platform for the free-form sharing of ideas promotes an open culture and a flat organization.”

 

  1. “I think threats are always opportunities…and I think the opportunity for us is to focus on the users and innovate.” There are two important ideas at work here. First, most positive most things in life have a negative flip side. I have a friend who likes to say about these situations arising in business: “You can’t eat ice cream all the time without getting fat.”  I will avoid the ever-present and often debunked reference to Chinese characters having double meanings. You may have encountered a version of this saying in an episode of the Simpsons: Lisa: “Look on the bright side, Dad. Did you know that the Chinese use the same word for ‘crisis’ as they do for ‘opportunity’? Homer: Yes! Cris-atunity.” But the essence of the story is true. In engineering and life, there are often inevitable tradeoffs.  And one of those tradeoffs is that what is most challenging is usually a huge opportunity. The other important point that Marissa Mayer is making here is that she is focused on innovation which benefits users. There are many types of innovations but not all of them benefit users. If they are not reminded of this engineers can often end up working on innovations that to do not translate into customer value. These innovations that do not benefit users may be quite interesting problems, but they do not drive the business forward.

 

  1. “We have this great internal list [at Google] where people post new ideas and everyone can go on and see them. It’s like a voting pool where you can say how good or bad you think an idea is. Those comments lead to new ideas.” Mayer discusses her approach to this opportunity in some detail in the Udemy Class linked to above. At Yahoo, she has launched an effort known as “PB&J” which is designed to rid Yahoo of dysfunctional “processes and bureaucracy and jams.”  Yahoo has created online tools to collect employee complaints and voting process which that stack rank PB&J problems so they can be addressed in an order which will produce the greatest impact. One consistent theme of these twelve quotations is that great ideas do not only come from the top of company management. As was specifically noted above, the job of a CEO is in no small part about clearing the way so other people in the business can get things done.

 

Notes:

Stanford Lecture

Wired – Mayer’s Secret Weapon

Disrupt interview

Davos (video)

Charlie Rose (video)

Vanity Fair – Marissa Mayer of Yahoo & Google

A Dozen Things I’ve Learned From Mark Suster About Venture Capital and Startups

Mark Suster blogs at Both Sides of the Table, which describes him as follows. “Mark Suster is a 2x entrepreneur turned VC. He joined Upfront Ventures in 2007 as a General Partner after selling his company to Salesforce.com.”

Writing this post on Mark Suster has been relatively easy since he writes and speaks clearly, thinks rationally and is generous with advice. He is also fearless in terms of the positions he takes on issues even if they are contrarian, which makes what he says quite interesting.

Coming up with twelve solid quotes from a public figure is not as easy as you might think. There are a lot of people I would *love* to write about but they are private and don’t say much in public about business or investing. Some people who would otherwise have a lot to teach about investing or startups work very hard to stay out of the press. Mark Suster is, by contrast, such a prolific source of material that instead of struggling to find quotes to include, I had to figure out what to cut out.

1. “If it’s your first time getting funding, you shouldn’t over-raise. Take whatever the right amount of money is for you, whether that’s $1 million, $5 million, or $10 million.” “Try to raise 18-24 month capital.” “When the hors d’oeuvres are passed, take two.… But, put one in your pocket.”

“What I like about raising less money is it allows you to move slower, and with a new company, you don’t really know what the demand [for your startup] will be. If you realize ‘holy crap, we’re on to something here,’ then you can always raise more money. “If you raise, say, $7 million off the bat, you’re on the express train. It’s either a big outcome or nothing if you assume investors are expecting 4X their money. Keep in mind that companies aren’t regularly bought for $100 million+ either.”

“VC’s want meaningful ownership … and the ‘fairway’ is 25-33% of your company.” “Be careful about ever dipping below 6 months of cash in the bank. You start fundraising when you have 9 months left and begin to panic if you get down below 3 months.” The only unforgivable sin in business is to run out of cash. But raising too much cash can also cause significant pain due to dilution. Getting the mix right between these two states is an art and not a science.  Of course, these are general rules, and the right amount to raise & to have on hand in any given case will depend on factors like

- the nature of the business (e.g., is it capital intensive; is customer acquisition cost high, how high is the burn rate) and

-the current state of the business cycle, which is constantly in flux. Venture capital is a very cyclical business.

As just one data point, Wharton recently quoted Pitchbook as saying: “in the past, Series A rounds meant entrepreneurs would give up roughly 33% of their company. This year, the average is around 27.7%.” That is after a seed round, and in today’s world you can get an extreme situation where startup has raised as much a $5 million in convertible debt before they do a Series A round. Bill Gates famously wanted enough cash in the bank to cover a full year of expenses in the early years of Microsoft, but (1) that was a different time and place with very different business models and (2) the business was generating that cash internally. Microsoft raised no venture capital, except for a small amount near the IPO to convince a specific investor to join the board of directors. Many people forget that when Microsoft went public Bill Gates owned about 50% of the company, which is a very rare thing. In contrast, some founders today have diluted themselves down to a few points of the equity by chasing fast growth in a cash consuming business model.

Finally, raising too much money can cause a lack of discipline and focus. Benchmark Capital’s Bill Gurley points out that “more startups die of indigestion than starvation.” Someone pointed out this week that too much money also means that issues and problems that should be dealt with by company culture are resolved instead by money which can mean that long term stability is threatened.

 

2. “There is no “right” amount of burn. Pay close attention to your runway.” “Your value creation must be at least 3x the amount of cash you’re burning, or you’re wasting investor value. Think: If you raise $10 million at a $30 million pre ($40 million post) that investor needs you to exit for at least $120 million (3x) to hit his/her MINIMUM return target that his/her investors are expecting. So money spent should add equity value or create IP that eventually will.” “Raising venture capital is like adding rocket fuel to your company… — which leads to a lot of bad behavior.” There is a big difference between a cash burn rate that is too high and valuations that are too high. The press has a huge tendency to transform a comment about burn rates being too high into a comment about valuations being too high. I suspect this happens because the concept of wealth is both easier to understand and a topic that readers are fascinated with.

Valuation and burn rate are not the same. Businesses can be spending too much cash in an environment where valuations are reasonable. Spending too much cash is a fast ticket to dilutionville or a broken capitalization table, which is an ugly place to be. Having some cash in reserve can come in very handy when markets essentially stop providing new cash for a period of time. Bill Gurley has told a great story about how OpenTable had to cut its cash burn rate severely when the ability to raise new cash dried up in the early 2000’s (when the Internet bubble popped) and the company was able to hang on for many years until growth resumed. Since market disruptions in the short term can’t be predicted with certainty, some amount of cash cushion has positive optionality. The question is not whether a cash reserve is needed, but how much. Danielle Morrill has a great post on burn rates which includes a $200K fully burdened cost-per-employee.

 

3. “The average VC – traditional VC – does 2 deals per year… from maybe 1,000 approaches.” Don’t take it personally if a VC does not want to invest in your startup. There are many reasons that potential investors say no. Also, try not to forget that the numbers cited by Mark Suster obviously mean that the top 100 VCs (individuals not firms) only make ~200 investment a year. Given that about 4,000 startups want to get funded in a given year, not all of them will be funded by a top 100 VC. The scarcest asset a VC has is time, and as a result they can only be he helpful to so many portfolio companies and on so many company boards. In other words, a great VC is more time-limited than capital-limited. If you do get funded, it will likely be after making a significant number of unsuccessful approaches and actual pitches. Some people can get funded quite quickly because of their reputation but they are the exception and not the rule. The venture capital firm Bessemer has a nice page that lists all the startups they rejected.

 

4. “You have to ask for the order.” Success in the venture business is way more dependent on sales skills than people imagine. VCs, founders and startup executives are constantly selling. The range of things that must be sold is long. Selling the prospects of the business to potential new employees is a huge part of what must be done for a startup to be a success. They are selling services and products, but also to potential investors and employees. If you don’t want to spend time and effort selling these things, starting a company is not something you will be much good at. And to sell successfully, you need to “ask for the order” since if you don’t do this you will never close a sale. The best product or service does not always win if the team does not learn how to sell it. As John Doerr said once: “Believe me, selling is honorable work — particularly in a startup, where it’s the difference between life and death.”

 

5. “Tenacity is probably the most important attribute in an entrepreneur. It’s the person who never gives up—who never accepts ‘no’ for an answer.” “what I look for in an entrepreneur when I want to invest? I look for a lot of things, actually: Persistence (above all else), resiliency, leadership, humility, attention-to-detail, street smarts, transparency and both obsession with their companies and a burning desire to win.” There are times in the life of every successful startup when they seem to be flying inches from disaster and close to death. If the founders and leadership of the company lose their nerve the outcome is very seldom pretty. Jane Park (the founder of e-commerce startup Julep) tells a great story about how the 2007 financial crisis took her company to the brink of running out of cash, and how she had to borrow $100,000 from her parents to save the business. That was courageous not only on her part but her parents, given that it was 50% of the money they had saved at that point in their lives toward retirement. The other great part of the story is how she used analytics to save her business. The data told her that people were not coming in as often, but were spending just as much when they did visit. By creating a loyalty program, Julep was able to get though the crisis. That’s a fantastic example of tenacity.

 

6. “I hate losing. I really hate losing. But you need to embrace losing if you want to learn. Channel your negative energy. Revisit why you lost. Ask for real and honest feedback. Don’t be defensive about it—try to really understand it. But also look beyond it to the hidden reasons you lost. And channel the lessons to your next competition.” “I think the sign of a good entrepreneur is the ability to spot your mistakes, correct quickly and not repeat the mistakes. I made plenty of mistakes.”

“The excuse department is now closed.” “There are a lot of people with big mouths and small ears. They do a lot of talking; they only stop to listen to figure out the next time they can talk.” Learning from your mistakes is such a simple idea. There is nothing like rubbing you nose in a mistake to force yourself to confront what needs to be changed. The best founders actually change rather than merely talking about change. One way to identify mistakes is to have people you can trust to tell you things they see from a different perspective. If you have someone who is loyal and trustworthy, who listens well and has good judgment, you truly have something that is invaluable. People like Coach Bill Campbell have these qualities, which explains their popularity as advisors.

 

7. “It’s the down market that real entrepreneurs are formed.” The best time to form a business is often in a down market. People are easier to recruit and there is less competition. The poseur founders and employees tend to run for safety during a down market, so that is helpful too since there is transparency on who’s willing to take risks and bet big. One of Warren Buffett’s most famed quotes is on this point: “Be greedy when others are fearful, and fearful when others are greedy.” Google was founded in September 1998 and when the Internet bubble popped a few year later, their ability to hire great people was enhanced by the downturn.

 

8. “If you have options in life, you won’t get screwed.” Getting to Yes by Roger Fisher became one of the best-selling books of all time based on this simple idea. In that book, Roger Fisher taught readers about the importance of having a BATNA (Best Alternative To a Negotiated Agreement). When you have an alternative, you can get a better set of terms and price. That Fisher’s insight was a big enough revelation to turn into his book a massive bestseller is, well, amazing, but then there it is. He developed the book at Harvard and that did help put an academic gloss on what anyone paying attention in life should know. As a simple example of this principle in operation, you should never say you will buy anything before agreeing on terms – including price. As another example it is wise to have multiple suppliers, unless they are selling a commodity.

 

9. “You can read lots of books or blogs about being an entrepreneur, but the truth is you’ll really only learn when you get out there and do it. The earlier you make your mistakes the quicker you can get on to building a great company.” “If you’re going to lead an early stage business you need to be on top of all your details. You need to know your financial model. You need to be involved in the product design. You need to have a details grasp of your sales pipeline. You need to be hands on.”

“The skill that you need to be good at to be effective as an entrepreneur is synthesis.” “Don’t let your PR get ahead of product quality.” “Your competitors have just as much angst as you do. You read their press releases and think that it’s all rainbows and lollipops at their offices. It’s not. You’re just reading their press bullshit.” “Do not be dismissive of your competition.” Successful founders tend to have a big bag of skills which are the result of a mix of real world experience and natural aptitude. Everyone makes mistakes but some people have an ability to make a higher ratio of new mistakes to repeated mistakes. Successful founders pay attention and learn. They naturally know how to multitask. In addition, they are almost always readers. And they surround themselves with smart people who also confront their own mistakes. One good test of whether you are looking at your mistakes is: have you changed your mind on any significant issues over the past year? If you have not, how deep are you digging? How much are you thinking?

 

10. “Entrepreneurs don’t “noodle,” they “do.” This is what separates entrepreneurs from big company executives, consultants and investors. Everybody else has the luxury of “analysis” and Monday-morning quarterbacking. Entrepreneurs are faced with a deluge of daily decisions – much of it minutiae. All of it requiring decisions and action.” I was in a meeting with a group of VCs once on Sand Hill road in the 1990s, and someone referred to a particular executive as “Mr. Ship.” This was meant as a compliment. What the person meant was this executive shipped promised product on time. Getting things done is an underrated skill. People who can generate a few months of publicity and look swell gazing off into the distance in a cover photo of a tech publication is an overrated skill. For a look at the things a founder must do to succeed, I suggest you read my post on Bill Campbell.

 

11. “Don’t hire people who are exactly like you.” “When I see a CEO who takes 90% of the minutes of a meeting I assume that as a leader that person probably doesn’t listen to others’ opinions as much as they should. Either that or he/she doesn’t trust his/her colleagues. Let your team introduce themselves.” Diversity in the broadest possible sense makes for better team. Different skills, different personalities, different interests, different methods, different backgrounds, etc. People who get things done know how to hire other people with complementary skills. Mark Suster is also pointing out that a genuinely functional team does not rely on a single person to get things done.

 

12. “Focus on large disruptive markets.” “We want the 4 M’s: management, market size, money, momentum.” “In startup world, low GM almost always equals death which is why many Internet retailers have failed or are failing (many operated at 35% gross margins). Many software companies have > 80% gross margins, which is why they are more valuable than say traditional retailers or consumer product companies. But software companies often take longer to scale top-line revenue than retailers so it takes a while to cover your nut. It’s why some journalists enthusiastically declare, ‘Company X is doing $20 million in revenue’ (when said company might be just selling somebody else’s physical product) and think that is necessarily good while in fact that might be much worse than a company doing $5 million in sales (but who might be selling software and have sales that are extremely profitable).” There are a range of things that a VC is looking for when investing in a startup. Mark Suster identifies some of these things throughout these twelve quotes: Large addressable market. Significant optionality. High gross margin. The time it takes to cover your expenses. He also points to one of my biggest pet peeves about business: journalists who are obsessed with the top line revenue of a business. Unfortunately, these journalists too often pass this obsession with top line revenue on to others.

I have easily said this thousand times: revenue does not equal profit. It is such a simple idea and it only requires grade school math to understand. I included this quote in my post on Jeff Bezos and it is appropriate to quote it again: “free cash flow, that’s something that investors can spend. Investors can’t spend percentage margins… What matters always is dollar margins: the actual dollar amount. Companies are valued not on their percentage margins, but on how many dollars they actually make, and a multiple of that.”

 

Notes:

I recommend all of Mark Suster’s posts at Both Sides of the Table

Both Sides of the Table - What is the right burn rate?

Walker Corporate Law – Mark Suster on helping entrepreneurs succeed

Huffington Post – Mark Suster’s Eight Steps for Startup Success

Both Sides of the Table – The Very First Startup Founder you need to Invest in is You

Stanford University – Mark Suster speaks at Stanford

Techcrunch - Fail Week: Guest Mark Suster (video)

PandoDaily interview (video)

A Dozen Things I’ve Learned From Bill Ackman about Value and Activist Investing

Bill Ackman is the founder of the investment holding company Pershing Square Capital Management. This post will focus on only one aspect of Bill Ackman’s investing system: his underlying belief in value investing principles. That Bill Ackman uses value investing principles at all may be a surprise to some people, since he is most known for being an activist investor. Since activist investing is often both controversial and confrontational it generates a lot of press interest. That often leaves the value investing part of his system in the background, but that does not mean it is less important.

At the 2014 Berkshire shareholder meeting, Warren Buffett was asked about activist investing. Buffett put the activist investing style into two different buckets. He approves of activists who are “looking for permanent changes in the business for the better” but disapproves of activists “looking for a specific change in the share price of the business.” In my view, this matches closely with Buffett’s definition of investing versus speculation. If you’re an investor, you’re trying to understand the value of the asset. By contrast, a speculator is trying to guess the price of the asset by predicting the behavior of other investors. Charlie Munger, at the same 2014 Berkshire meeting, commented that there is far too much activism that is based on price and not value by saying: “It’s not good for America, what’s happening. It’s really serious.” Unfortunately, there is no bright line that separates investing from speculation.

When asked about what Buffett and Munger said at that 2014 Berkshire meeting, Bill Ackman introduced a time dimension. Bill Ackman told Bloomberg: “I 100 percent agree with them. [Seeking short-term gains without creating better businesses] is bad for markets, and it’s bad for shareholders” [Pershing Square typically holds stakes] “four, five, six years or more.” Carl Icahn, when commenting in what Buffett and Munger said, also introduced a time element: “I understand and somewhat agree with their criticisms that some activists are going for a short-term pop.” Which actions are improper short-termism and which are appropriate actions to increase shareholder value, also lacks a bright line test.

That there is no bright line does not mean that these questions can’t be sorted out in a reasonable manner by using a healthy dose of common sense. For example, Buffett’s standard on buy backs, whether advocated by an activist or initiated by company management, is as follows: “First, a company [must have] ample funds to take care of the operational and liquidity needs” and “Second, its stock [must be] selling at a material discount to the company’s intrinsic business value, conservatively calculated.”

As I promised, the focus of what follows in this blog post is on the value investing part of Bill Ackman’s investing system.

 

1. “Short-term market and economic prognostication is largely a fool’s errand, we invest according to a strategy that makes the need to rely on short-term market or economic assessments largely irrelevant.” Value investing has three bedrock principles that are inviolate and will be identified in italics and discussed throughout this post. The first of these bedrock principles is:  Make Mr. Market your servant, not your master. Investors who follow this principle understand that if you wait patiently Mr. Market will inevitably deliver his gifts to you as his mood swings unpredictably in a bi-polar fashion from greed to fear. The trick is to buy when Mr. Market is fearful and sell when Mr. Market is greedy. If you must predict the direction of the market in the short term to win, Mr. Market is your master and not your servant. Anyone who has been reading this series of posts on my blog has seen investor after investor talk about the folly of trying to make short-term predictions about markets.

 

2. “You read [Ben Graham] and it is either an epiphany and it affects the way you live your life, or it’s of no interest to you… I found it fascinating.” I have encountered the phenomenon which Bill Ackman is referring in this quote many times in my life. Warren Buffett and Seth Klarman both say value investing is like an inoculation, either you get it right away, or you don’t. Value investors use fundamental analysis as part of the value investing system to decide whether to make a bet a about whether something will happen and don’t fool themselves that they can time when that will happen. People who are not successfully inoculated into value investing most often fail to see the difference between waiting opportunistically for something to happen and trying to predict when something will happen.  Waiting opportunistically for something to happen is not predicting.  Arguments that the unchanging assumptions that underlie value investing are predictions are a rhetorical sideshow. If you don’t understand the “patiently waiting, then opportunistically pouncing rather than predicting” element to value investing, you won’t ever understand value investing. This explains why a core attributes of successful value investing are patience and a willingness act differently than the crowd. In other words, some people internalize the importance of the idea that Mr. Market should be treated as your servant and some don’t.

 

3. “You should think more about what you’re paying versus what the business is worth. As opposed to what you’re paying versus what they’re going to earn next quarter.” “Don’t just buy a stock because you like the name of the company.  You do your own research.  You get a good understanding of the business.  You make sure it’s a business that you understand.  You make sure the price you’re paying is reasonable relative to the earnings of the company.” The second bedrock principle of value investing is: treat a share of stock as a proportional interest in a business. A share of stock is not a piece of paper to be traded based on what you think, others will think, about what others will think [repeat] about the value of a piece of paper.  To be successful at value investing, you must understand the actual businesses in which you invest. This means you must do a considerable amount of reading and research and work to understand the fundamentals of the business. If you are not willing to do that work, don’t be a value investor. Bill Ackman has said on this point: “Find a business that you understand, has a record of success, makes an attractive profit, and can grow over time.” What could be more simple?

 

4. “Our strategy is to seek to identify businesses … which trade in the public markets for which we can predict with a high degree of confidence their future cash flows – not precisely, but within a reasonable band of outcomes.” The third bedrock principle of value investing is:  Margin of safety! A margin of safety is a discount to intrinsic value which should be significant to be effective. Warren Buffett wrote to Berkshire shareholders in 1994: Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.” Buying at a significant discount to intrinsic value (e.g., 25%) creates a margin of safety.  If you have a margin of safety you don’t need to precisely predict intrinsic value, which is a somewhat fuzzy concept that different people calculate in slightly different ways. This explains Bill Ackman’s use of the phrase “reasonable band of outcomes.” The important thing about intrinsic value is that you only need to be approximately right, rather than precisely wrong.

 

5. “Often, we are not capable of predicting a business’ earnings power over an extended period of time. These investments typically end up in the ‘Don’t Know’ pile.” This quotation is about what a value investor calls “circle of competence.” This aspect of value investing is handled by different value investors is different ways, so it is not a bedrock principle in my view. Sometimes the intrinsic value of a given business can’t be calculated, even by an expert. This is not a tragedy.  There are plenty of other businesses which do have an intrinsic value that can be calculated within a reasonable band of outcomes. Risk comes from not knowing what you are doing. When you don’t know what you are doing, don’t do anything related to that lack of knowledge. One key attribute value investors have is being calm as Buddha when muppets are screaming at them to do something. You don’t need to swing at every pitch. Almost all of  the time the best thing to do is nothing. Having a “too hard” pile is tremendously valuable.

“…for an individual investor you want to own at least 10 and probably 15 and as many as 20 different securities.  Many people would consider that to be a relatively highly concentrated portfolio.  In our view you want to own the best 10 or 15 businesses you can find, and if you invest in low leverage/high quality companies, that’s a comfortable degree of diversification.”  One publication notes that Bill Ackman runs a concentrated portfolio “generally owning fewer than 10 companies, with a high concentration of his portfolio invested in his top two or three picks.” Charlie Munger calls this style “focus investing,” which is very different from an investor like Joel Greenblatt who was recently quoted in the press saying that he owns 300 names. On this question of diversification, value investors can often differ, so it is not a bedrock principle. In fact, there are many ways that value investors can successfully differ as long as they follow the three bedrock principles.

 

6. “We like simple, predictable, free-cash-flow generative, resilient and sustainable businesses with strong profit-growth opportunities and/or scarcity value. The type of business Warren Buffett would say has a moat around it.” You want to buy a business that is going to exist forever, that has barriers to entry, where it’s going to be difficult for people to compete with you… You want a business where it’s hard for someone tomorrow to set up a new company to compete with you and put you out of business.”

“The best businesses are the ones where they don’t require a lot of capital to be reinvested in the company.  They generate lots of cash that you can use to pay dividends to your shareholders or you can invest in new high-return, attractive projects.” This is a clean description of the key attributes a value investor looks for in a business, and my further commentary won’t add much. The core point being made here is simple: if there is no barrier to competition, the competitors of any business will drive profit down to the opportunity cost of capital.  Bill Ackman’s goal is to discover businesses with a moat that are mispriced by the market. On this I suggest you read Michael Mauboussin on Moats, and my post on Michael Porter

 

7. “People seem to be happier buying something at 50 percent off for $50 as opposed to having it marked at $40 and there being no discount, which is sort of an interesting psychological phenomenon. But it’s real.”

“To be a successful investor you have to be able to avoid some natural human tendencies to follow the herd.  When the stock market is going down every day your natural tendency is to want to sell. When the stock market is going up every day your natural tendency is to want to buy, so in bubbles you probably should be a seller.  In busts you should probably be a buyer – you have to have that kind of discipline.  You have to have a stomach to withstand the volatility of the stock markets.” A child of ten knows that markets are not composed of perfectly informed rational agents. There are many dysfunctional heuristics which cause people to make poor decisions. If some people did not make poor decisions, being an investor who performs better than the market would not be possible. Someone else must make a mistake for an investor to outperform a market. Being an investor is fundamentally about searching for mispriced assets. No one speaks more clearly about this than Howard Marks.

 

8. “In order to be successful, you have to make sure that being rejected doesn’t bother you at all.” “Generally it makes sense to be a buyer when everyone else is selling and probably be a seller when everyone else is buying, but just human tendencies, the natural lemming-like tendency when everyone else is [doing something] you want to be doing the same thing, encourages you as an investor to make mistakes.” Being contrarian is not easy since people find comfort in being part of a herd. This feeling of comfort is no small part of why being an investor who outperforms the market is not easy. You must be comfortable with being criticized for your sometimes contrarian views and, of course, you must be right enough times about those contrarian views. If you don’t understand what Howard Marks says about mispriced assets, do yourself a favor and buy a diversified portfolio of low fee index funds/ETFs since you are not a candidate to be a successful active investor.

 

9. “The investment business is about being confident enough to know that you’re right and everyone else is wrong. Yet you have to be humble enough that you recognize when you’ve made a mistake. Earlier in my career, I think I had the confidence part pretty solid.  But the humbleness part I had to learn.’’ Knowing when to be humble and when to admit that you are wrong requires good judgment. Judgment tends to come from having bad judgment, or seeing others make bad judgments. Bill Ackman has said: “Experience is making mistakes and learning from them.” If press reports are to be believed, there are people who think that Bill Ackman is not humble. But those people don’t seem to be very humble themselves. Bill Ackman has said of Icahn: “He’s a bully who thought of me as road kill on the hedge fund highway.” Icahn countered: “I wouldn’t invest with you if you were the last man on Earth.”

 

10. “When you go through something like the financial crisis, it makes a psychological imprint on you. It becomes hard to interpret information in a way that is positive.”

“A lot of people talk about risk in the stock market as the risk of stock prices moving up and down every day.  We don’t think that’s the risk that you should be focused on.  The risk you should be focused on is if you invest in a business, what are the chances that you’re going to lose your money, that there is going to be a permanent loss.” “[The] key here is not just shooting for the fences, but avoiding losses.” People have a tendency to acquire what people in the sports world call “muscle memory” when exposed to something. Memories of things like touching a hot stove or encountering a financial crisis tend to be particularly strong. People who have decades of experience as investors have seen times when the ability to generate new cash dries up in a matter of days, and when people seem to have wealth but can’t generate any new cash.

Here’s Buffett on the value of cash: “We will always have $20 billion in cash on hand. We will never depend on the kindness of strangers. We don’t have bank lines. There could be a time when we won’t be able to depend on anyone. We have built Berkshire for too long to let that happen. We lent money to Harley-Davidson at 15% when interest rates were 0.5%. Cash or available credit is like oxygen: you don’t notice it 99.9% of the time, but when its absent, it’s the only thing you notice. We will never go to sleep at night without $20 billion in cash. Beyond that, we will look for good opportunities. We never feel a compulsion to use it, just because it is there.”

 

11. “Investing is one of the few things you can learn on your own.” “You can learn investing by reading books.” “I went to business school to learn how be a good investor. When I got to Harvard Business School and I opened the course catalog for the first time and discovered there wasn’t a class on investing. I decided I had to open my first self-study program.” It is amazing how much you can learn by reading and paying attention to what happens in your life and in the lives of others. That applies in life generally, but especially in investing. Investing involves a range of ideas that are far more easy to learn than they are to put into practice. 

If you are reasonably smart, work hard, read a lot, and can keep control of your emotions it is possible to be a self-taught investor. Many good and a few great books on investing have been written. I would rather re-read a great book that read a mediocre or lousy book for the first time. That many business schools do not teach investing (specifically value investing) is, well, bonkers. How does a CEO or CFO allocate capital without understand investing principles? The answer is too often: not very well and with poor results. Buffett has written: “The heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics. Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered.” That business schools are not more focused on training executives to intelligently allocate capital is unfortunate, to put it mildly.

 

12. “Buy high-quality businesses at a price that is not reflective of the intrinsic value of the business as it is, and certainly not reflective of what the intrinsic value would be if it were run better. That allows us to capture a double discount. That’s a benefit we can have over private equity. They can buy a company and run it better to extract incremental value, but they’re typically paying the highest price in a competitive auction, so they don’t get that first discount. We don’t get full control, but because we have a track record of making money for other investors, we can often exert enough control to make an impact.” “Our greatest competitive advantage, though, comes from using our stake in a company to intervene in the decision-making, strategy, management or structure of the business. We don’t like waiting for the market to be a catalyst.”  

 

As I said above, Bill Ackman differs from most value investors in that he is also an activist shareholder. Here is Ackman’s pitch:

 

“‘I call them happy deals, not hostile deals…Unsolicited, I think, is a little more gentlemanly. I think it’s also more accurate.’ And while he’s at it, he’d rather people didn’t call Pershing Square a hedge fund. He would prefer ‘investment holding company.’ “When people think hedge fund, they think highly levered, short-term trading-oriented, you know, arbitragers, where we are very different from that,’ he said. Pershing Square is ‘really much more similar to Berkshire Hathaway.’”WSJ

Is Pershing Square really similar to Berkshire? The two investors share value investing as a core activity, but not “unsolicited” activism. Warren Buffett may have early in his investing career tried to turn around some businesses, but as a whole his attempts at activism were not a rousing success. Buffett seems to have abandoned that style of investing. In a 2014 interview, Buffett said: “You might say I took an active role in Berkshire Hathaway in 1965 when I took control, but we’re not looking to change people. We may be in a situation with them where [taking an active role] might influence, but we want to join with people we like and trust. We will not come in in a contentious way – it’s just not consistent with Berkshire principle.”

Charlie Munger simply described some of the reason for this shift at Berkshire regarding active investing earlier this year: “Berkshire started with three failing companies: a textile business in New England that was totally doomed because textiles are congealed electricity and the power rates were way higher in New England than they were down in TVA country in Georgia. A totally doomed, certain-to-fail business. We had one of four department stores in Baltimore [Hochschild Kohn], absolutely certain to go broke, and of course it did in due course, and a trading stamp company [Blue Chip Stamps] absolutely certain to do nothing, which it eventually did. Out of those three failing businesses came Berkshire Hathaway. That’s the most successful failing business transaction in the history of the world. We didn’t have one failing business – we had three.”

Warren Buffett has famously said: “Turnarounds seldom turn.”  The failure of a business to ‘turn around’ is a good description of Bill Ackman’s unsuccessful JC Penney investment and Buffett’s own losses in department stores and retail. The turnaround strategy worked well for Bill Ackman in the case of companies like Canadian Pacific. What Canadian Pacific as a value investing stock did was provide potential upside plus limit downside if the turnaround failed. In short, that a business is a bargain by value investing standards creates a margin of safety, which can be a very good thing for any  investor.

 

Notes:

Bio of Bill Ackman

Charlie Rose - Interview with Bill Ackman 

Saïd Business School – Conversation with Bill Ackman

The Floating University – Bill Ackman Lecture Transcript 

Big Think – Everything You Need to Know About Finance and Investing in Under an Hour (video)

Bloomberg News – Rules for Investing like a Maverick (video)

The Floating University – The Psychology of Investing (video)

Investary Group – Icahn and Ackman (video)

 

A Dozen Things I’ve Learned From Bill Murray about Business, Money, Startups, Investing and Life in General

The challenge I gave myself with this blog post was to take quotations from Bill Murray (the actor and comedian) and apply his advice to investing.  Writing this has been like one of those cooking competition shows where you get some ingredients in a basket (for example, cotton candy, spam, kiwifruit and pimento cheese) and you must make a delicious meal with it using other ingredients that are in the pantry. I decided to throw in Charlie Munger as my other ingredient in this post, since he can make almost anything make more sense. Charlie Munger is the investing equivalent of butter in cooking since his wisdom makes almost anything taste better.

The task is actually easier than it seems. Investing is mostly about making wise decisions, and many people like Bill Murray who aren’t professional investors have learned strategies to make better decisions – especially after making some less-than-good decisions over the years.  Learning to make better decisions most often comes from having made bad decisions in the past, and actually paying attention to the reasons why they were bad decisions.

Here are the Bill Murray quotations in bold text, followed by my thoughts interweaved with the views of Charlie Munger.

1. “I try to be alert and available. I try to be available for life to happen to me.” “Eh, it’s not that attractive to have a plan.”  This advice from Bill Murray is straight-up consistent with Charlie Munger, who believes: “[Successful investing requires] this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.”  The Murray/Munger approach is simple: Don’t try to predict the future. Be patient, alert to opportunity, and ready to act aggressively when the time is right. In looking for optionality, it is essential that the optionality be mispriced by the market. The approach followed by Bill Murray preserves optionality and enables him to take advantage of mispriced bets that don’t happen very often.

This quote from Bill Murray’s character in Ghostbusters is a great example of the right attitude in a situation with positive optionality: “If I’m wrong, nothing happens. We go to jail — peacefully, quietly. We’ll enjoy it. But if I’m right, and we CAN stop this thing… you will have saved the lives of millions of registered voters!” Small downside and big upside is the essence of optionality, which is the essence of business and investing. When you see a huge potential upside with a small downside in business or investing, you should grab the opportunity.

Nassim Taleb wrote in Antifragile: “the idea present in California, and voiced by Steve Jobs at a famous speech: “Stay hungry, stay foolish” probably meant “Be crazy but retain the rationality of choosing the upper bound when you see it…. Any trial and error can be seen as the expression of an option, so long as one is capable of identifying a favorable result and exploiting it…”

2. “I think we’re all sort of imprisoned by — or at least bound to — the choices we make…. You want to say no at the right time and you want to say ‘yes’ more sparingly.”  Most of the time in life when you are asked to do something, the best thing to do is nothing.  Saying “yes” too often can destroy positive optionality. For Bill Murray this means things like not accepting every movie offer that come along. Charlie Munger puts it this way: “When Warren lectures at business schools, he says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

I have this friend who likes to say “when someone wants to hand you a turd, don’t feel obligated to take it.”  It’s a pretty simple idea that many people forget. The correct response when someone tries to hand you a turd is: “Hey, thanks for thinking of me, but no thanks. You can keep that turd. Have a nice day.”

3. “What do they give you to do one of these things?” And they said, ‘Oh, they give you $50,000.’ So I said, ‘Okay, well, I don’t even leave the fuckin’ driveway for that kind of money’.” Bill Murray is describing an opportunity cost analysis here. Two of the more important opportunity costs in life involve time and money. Of course, time is the most precious opportunity cost of all. Charlie Munger’s description of the same process is as follows:  “…intelligent people make decisions based on opportunity costs — in other words, it’s your alternatives that matter. That’s how we make all of our decisions.”

The funny part of the story related to Murray’s quote is that it concerned his decision to do the voice of Garfield in an animated movie. He ended up taking the part because he thought a Coen brother was involved. Murray said: I had looked at the screenplay and it said ‘Joel Cohen’ on it. And I wasn’t thinking clearly. It was spelled Cohen, not Coen.”

4. “Don’t walk out there with one hand in your pocket unless there’s something’ in there you’re going to bring out.” You gotta commit.” “Let’s just roar a little bit. Let’s see how high we can go.” When you see an opportunity to make a bet that has odds substantially in your favor, you should bet big. Otherwise, don’t bet more than is needed to stay in the game. Charlie Munger: “The chief thing I learned from poker was that when you really have an edge, you have to push hard because you don’t get edges that often.” Often that bet is about time as well as an emotional and intellectual commitment, not just money. Going “all in” can be fun as hell.

 

5. “I made a lot of mistakes and realized I had to let them go. Don’t think about your errors or failures, otherwise you’ll never do a thing.”  You will never stop making mistakes, so dwelling on mistakes does you no good. A trick to making wise decisions in life and in business is recognizing the poor decisions you and people you know have made, and understanding why they were poor decisions. Then, try to learn as much from those experiences as you can, to help you make a higher ratio of new mistakes to old mistakes.

The world does not stop being an unpredictable nest of complex adaptive systems because you are getting older and, on the margin, a bit wiser. This quote reminds me of a story about a young woman who attends a church near my home. After the sermon was over one Sunday, she lingered after the other members had shook hands with the minister on their way out. As the young woman finally shook hands with the minister, she asked, “Reverend, do you believe someone should profit from the mistakes of others?” “Certainly not,” replied the minister. “Well, in that case, could I have the $300 back that I gave you for officiating my marriage?”

 

6. “You have to hope that [good things] happen to you… That’s the only thing we really, surely have, is hope.”  Bill Murray is talking about the value of optimism. In this way Bill Murray is more like Warren Buffett than Charlie Munger, who has said:I don’t see how anybody could be more optimistic that Warren. He has this real faith in the long term. I’m not quite so enthusiastic, but he’s right that there’s a lot good that’s happening.” Being positive is, well, a positive thing. As an analogy, in terms of characters from The Hundred Acre Wood, it is far better to be a mix of Owl and Tigger, than Eeyore. As for Charlie Munger, his view is: “Is there such thing as a cheerful pessimist? That’s what I am.”

I think optimism is the better approach, but sometimes we are who we are. There’s a old joke about this idea: A family had twin boys, who had very different personalities even though they were identical twins. One boy was an eternal optimist, the other a complete pessimist.  Just to see what would happen, on the twins’ birthday their father loaded the pessimist’s room with a huge pile of toys and games. In the optimist’s room, he brought in a huge pile of horse manure. That night the father visited  the pessimist’s room and found him sitting next to his new gifts crying bitterly.  “Why are you crying?” the father asked. “Because my friends will be jealous, I’ll have to read all these instructions before I can do anything with this stuff, I’ll constantly need batteries, and my toys will eventually get broken,” answered the pessimist twin. The father then went to the optimist twin’s room and father found him happily digging deep in the pile of manure. “What are you so happy about?” the father asked. The optimist twin replied: “There’s got to be a pony in here somewhere!”

There’s a joke about this topic that goes like this: Two friends, one an optimist and the other a pessimist, could never quite agree on anything it seemed. The optimist hatched a plan to pull his friend out of his pessimistic thinking. The optimist owned a hunting dog that could walk on water. His plan was to take the pessimist and the dog out duck hunting in a boat. They got out into the middle of the lake, and the optimist brought down a duck. The dog immediately walked out across the water, retrieved the duck, and walked back to the boat. The optimist looked at the pessimistic friend and said: “What do you think about that?” The pessimist replied: “That dog can’t swim, can he?”

 

7. “When you play with great players, you play better, it just elevates your game.” Working with smart people makes you smarter, and that feeds back on itself in a recursive way. Success of all kinds feeds back on itself in a process called “cumulative advantage.” Being lucky and talented leads to exposure to other talented people, experiences and training that makes you more talented [repeat]. Of course, some people are born on third base and have convinced themselves they hit a triple.  Bill Murray is about as far from that as you get – even though he is an actor. He will, occasionally, comment on the economy. He once said: “A few decades ago we had Johnny Cash, Bob Hope and Steve Jobs. Now we have no Cash, no Hope and no Jobs. Please don’t let Kevin Bacon die.”

 

8. “The [work] I like most [is] where I connected with great people.” This quote is slightly different that the previous one, since this point is about how much you enjoy something rather than what makes you more skilled. Charlie Munger: “Even Einstein didn’t work in isolation. Any human being needs conversational colleagues.” Working with smart motivated people makes you smarter and more motivated. It is a virtuous cycle when you get it right. If you are just working to make money and are not in that process connecting with great people, it may be work, but its not really living.

 

9. “It’s hard to be anything.” Lots of aspects in life and business are simple, but not easy. It is emotions and psychology that make both investing and life hard. Charlie Munger: “If [investing] weren’t a little difficult, everybody would be rich.” If things aren’t going well, keep working. Never give up. Be relentless. That time in life when nothing is hard is when you are dead. There’s no need to rush that.

Even though life is hard, try to look on the bright side, like the Bill Murray character Spackler in the movie Caddyshack: “And I say, ‘Hey, Lama, hey, how about a little something, you know, for the effort, you know.’ And he says, ‘Oh, uh, there won’t be any money, but when you die, on your deathbed, you will receive total consciousness.’ So I got that goin’ for me, which is nice.”  

 

10. “You need all kinds of influences, including negative ones, to challenge what you believe in.” Charlie Munger expresses a similar view:  “Any year that passes in which you don’t destroy one of your best loved ideas is a wasted year.” If you are not being challenged, you are not growing. As you go through life if you are not discovering that the amount that you know you don’t know is growing even faster than what you do know, you are not paying attention.

If you don’t get excited when you are wrong about something and understand why you were wrong, that is actually a bit of a tragedy. You are very unlikely to be a good investor if that is the case. Anthony Bourdain said once, on his preconceptions of Ferran Adria’s Michelin 3-star restaurant elBulli the first time he ate there, “I like being wrong about things.” I agree with Andy Bourdain. Being wrong occasionally is the way people learn. Some people refuse to admit when they are wrong, and are terrible investors as a result.

 

11. “The gratification part is: I worked with that son of a bitch. I worked with her. If you get that thing done, you’re professional friends for life. There are people who drove me crazy, but they got the job done. And when I see that person again, I nod my head. Respect.” There’s nothing like a shared experience to bring people together. This shared experience is powerful enough that you can end up with a bond with people you never would have been friends with otherwise. When that creative process results in something valuable, it is not only gratifying but also creates a treasured bond with the people who were involved in that shared experience.

 

12. “[When I saw Ivan Reitman’s early cut of “Ghostbusters] I knew I was going to be rich and famous, and be able to wear red pants and not give a damn.” GQ’s Dan Fierman wrote about Murray in a 2010 interview: “If [Bill Murray’s] three and a half decades in the public sphere have taught us anything about the actor, it’s that he simply does not give a good goddamn.” The best thing about money is that you have the option to be independent. You have choices when you have money. Conversely, people who are poor or even rich people who have lots of debt tend to have lousy options in life. What you want to avoid are situations where you only have two choices: take it or leave it.

Charlie Munger: “Like Warren, I had a considerable passion to get rich, not because I wanted Ferraris – I wanted the independence.  Having a lot of money and toys is over rated — having a lot of great choices is highly underrated. Cash has optionality that is valuable in and of itself. The ability to be exactly who you are and make the choices you want is a very wonderful thing indeed.

 

Notes:

Bill Murray Stories

PageSix – Bill Murray drove a taxi while the cabbie played sax in the back

Splitsider – Collected Wisdom of Bill Murray

DailyBeast – The Wisdom of Bill Murray

Huffington Post – Bill Murray Life Lessons

SNL Transcript – Caddyshack

Pajiba – Bill Murray’s Best Quotes on Acting & Fame

Funtrivia – Quotes from Ghostbusters

CNBC – Bill Murray’s View on the Economy

A Dozen Things I’ve Learned From Larry Ellison About Business

1. “The only way to get ahead is to find errors in conventional wisdom.” “Because conventional wisdom was in error, this gave us tremendous advantage: we were the only ones trying to do it.” “When you innovate, you’ve got to be prepared for everyone telling you you’re nuts.”  “When you’re the first person whose beliefs are different from what everyone else believes, you’re basically saying, ‘I’m right, and everyone else is wrong.’ That’s a very unpleasant position to be in. It’s at once exhilarating and at the same time an invitation to be attacked.” If you have been reading the profiles of successful investors and entrepreneurs on this blog there is probably no other point made so consistently than this: to outperform the market, you must sometimes be contrarian. Of course, you must also be right when being contrarian in enough of those cases that you outperform the market. It is a mathematically provable fact that you can’t beat the crowd if you are the crowd. Breaking at least one aspect of conventional wisdom is the only way to achieve something truly great. Breaking conventional rules or rejecting conventional assumptions for its own sake is unwise (and as an aside, even though being a someone being contrarian and someone being counterintuitive are different concepts, some people recently have improperly treated them as interchangeable).

Reid Hoffman has pointed out that if you are contrarian you ideally want being correct about that to cause a daisy chain of success. You also want the outcome of your contrarian view coming true to have positive optionality (small downside and a big upside).  You also don’t want to be in a situation where multiple contrarian predictions must happen for your business to become very profitable. Finally, the contrarian bet should be substantially mispriced in your favor (e.g., because you have superior domain expertise or others have lost control of their emotions).

Bill Gurley puts it perfectly here: “a lot of the [bets] that become the breakouts, break any rule set that you have created…” The question is: “Which of these rules am I going to break. What is the new truth going to be?” In other words, make your rule-breaking contrarian prediction count by only making it against an outcome that has huge positive optionality.  Don’t compound your odds of failure by requiring that you “bowl multiple strikes” in a row on contrarian bets to win.

 

2. “Software is not a capital‑intensive business. You can do it with on a shoestring. And all the great software companies started that way.” “The larger you are, the more profitable you are. If we sell twice as much software, it doesn’t cost us twice as much to build that software. So the more customers you have, the more scale you have.” Many people today have either (1) lost track of key aspects of how beautiful the traditional software business model that developed in the 1980s and 1990s can be or (2) are too young to know that this golden era of gushing up front free cash flow even exists. In the traditional software business model, you write software and people buy it. They pay in cash up front. After the software developer pays back its development expenses, incremental revenue is almost pure profit.  Fees are often based on peak usage not actual usage.

Some people advocating software as a service (SaaS) today like to say: “recurring revenue is the greatest thing since sliced bread.” Recurring revenue can indeed be nifty, but there is this thing called customer churn in a “lifetime customer value” based business model which means that what may seem to be recurring revenue, does not always recur. Someone can pretend that customer churn does not exist, just like someone can believe in Santa Claus. Recurring revenue does help avoid a situation where a customer licenses version X of the software and upgrades only after many years and in that way SaaS shares elements with yearly maintenance fees so beloved by Oracle. But the tradeoff with SaaS is that customers can churn more easily and buy only what they need instead of paying for peak capacity.

A dollar of almost pure profit paid up front is better for a provider than a dollar of revenue coming in later that may or may not generate any profit margins. Do customers love a business model where the provider supplies all the capex and supplies the services as SaaS? Yes! That’s new consumer surplus (i.e., what the customer gets).  That’s the future!  I’m “all in” on the cloud and SaaS because it is better for many consumers.

Is SaaS also a great way to compete against incumbents in established markets since the means of competition is asymmetric and harder to defend against? Yes!  If I started a new business today it would de SaaS? Yes. But in terms of producer surplus (what the software company gets), SaaS is neither good or bad in and of itself.  Larry Ellison is a billionaire who owns things like nearly all of the island of Lanai for a reason, and that reason isn’t that SaaS revenue is more predictable than Oracle’s traditional business model which includes things like cash paid up front by the customer, the customer being responsible for capex, and a yearly 20 percent plus maintenance fee payable to Oracle.

Again, I want to be perfectly clear that SaaS is great for consumers. It is the future. But is not an easy model to execute on (e.g., has less attractive cash low, can have high customer acquisition costs (CAC), has higher customer churn to manage, etc.) as compared to the traditional model. As an analogy, I liked it when I had no joint pain after exercise too, but I can’t go back, just like you can’t go back from offering pay-as-you-go SaaS to the traditional licensed business model for software.

 

3. “From the day we started the company, over the 17 years, we have had only one quarter [in which we lost money]. And, boy, even that was one too many.” Creating and selling software in the pre-SaaS days was magical if you established the right sort of business driven by network effects.  People paid up front in the software business and cash flowed like water at Niagara falls if you got it right. Is a SaaS market potentially vastly bigger today in terms of revenue? Yes! Is revenue the same things as profit? No. Is it fantastic that everyone has a connected super computer in their pocket? Yes!  Is the rise of SaaS inevitable? Yes! Is the shift to the new SaaS business model an unmitigated blessing for software producers? No.

 

4. “It’s like Woody’s Allen’s great line about relationships. A relationship is like a shark, it either has to move forward or it dies. And that’s true about your company.” Businesses that can adapt to change can thrive. Businesses that don’t adapt, die. The average lifespan of a business on the S&P 500 in 1960s was 60 years. Today, that average age is 10 years.  As I said in my comments on the past three quotations, SaaS based business models are part of the future. If you don’t accept that change, you are toast.

 

5. “The computer industry is the only industry that is more fashion-driven than women’s fashion.”  When you have been in the technology business as long as I have you have seen many concepts come and go. Information highway, e-business, clipper chip, Dodgeball, Clippy, Lively, etc. The list is endless. Both software and venture capital firms and investors love to chase a trend. As Bill Gurley said once: “Venture capital is a cyclical business.” The great venture capitalists are mostly done with new investments in a sector before the mob moves in and makes it a trend. The great venture capitalists also have money to invest in startups when the cycle is at its bottom (when it is out of fashion).

 

6. “To model yourself after Steve Jobs is like saying, ‘I’d like to paint like Picasso, what should I do? Should I use more red?” You are not going to be Steve Jobs, Larry Ellison or Bill Gates. Get over it, if that’s your goal. But you can look at qualities they have and chose some you would like to try to emulate, as you would in looking at a menu on a Chinese restaurant. I knew someone once who thought he needed to treat people like Steve Jobs treated people early in his career to be successful in a startup. That is a full load of rubbish.

 

7. “When I started Oracle, what I wanted to do was to create an environment where I would enjoy working. That was my primary goal.” “We used to have a rule at Oracle to never hire anybody you wouldn’t enjoy having lunch with three times a week. Actually, we are getting back to some of our original ideals these days.” Working with people you enjoy is highly underrated. Working with people you don’t enjoy is, well, odious. The great news is that working with people you enjoy is more likely to lead to success. You will end up with less loss from friction since you can benefit from a seamless web of deserved trust. Will you enjoy everyone you work with? No. But with a little work can you find a way to work with most people? Yes.

 

8. “I think I was interested in math and science because I was good at it. And people tend to like what they’re good at and not like very much what they’re not good at.” “I’ve never really run operations. I’ve never had the endurance to run sales. The whole idea of selling to the customer just isn’t my personality. I’m an engineer– tell me why something isn’t working or is, and I’m curious.” Larry Ellison is probably capable of doing what Mark Hurd does or even Safra Katz does.  But he is saying he does not enjoy doing those things. Doing what you enjoy is underrated.

 

9. “Great achievers are driven, not so much by the pursuit of success, but by the fear of failure.” I am not a fan of using failure as a motivational tool. But there is a little of this in everyone and a lot in others. Larry Ellison is obviously competitive. Going up against him in any competitive activity is an adrenaline rush.

 

10. “I think about the business all the time. Well, I shouldn’t say all the time. I don’t think about it when I’m wakeboarding. But even when I’m on vacation, or on my boat, I’m on e-mail every day. I’m always prowling around the Internet looking at what our competitors are doing.”  I have heard this joke for many years: The difference between God and Larry Ellison is that God Doesn’t Think He’s Larry Ellison. This joke widely misses the mark. If Larry Ellison really thought this way he would not be “always prowling around the Internet looking at what our competitors are doing.” He would not be driven by a “fear of failure.”

 

11. “All you can do is every day, try to solve a problem and make your company better. You can’t worry about it, you can’t panic when you look at the stock market’s decline.” If you execute well and focus on great strategy, the stock price will take care of itself.  The price of a stock is not the same thing as the value of a proportional share in a business. This point is fundamentally important to investing which is fundamentally about understanding business. A share of stock in a proportional ownership interest in a business and is not a piece of paper to be traded on popularity like a baseball card.  Ignore short term noise and shorty term price fluctuations cause by the bi-polar Mr. Market and you will be a better businessperson and investor. Only occasionally will the price and value of a business be the same. Knowing the difference between price and value is a critical part of successful investing.

 

12. “In some ways, getting away from headquarters and having a little time to reflect allows you to find errors in your strategy. You get to rethink things. Often, that helps me correct a mistake that I made or someone else is about to make. I’d rather be wrong than do something wrong.” Waking up before you make a mistake is a very good thing. The experience of actually peeing on the electric fence can sometimes be avoided if you think things through before you pee. Taking a break with something as simple as a walk or as complex as an America’s cup race is wise. Admitting you are wrong, especially before you are wrong in actually doing something, is a very good thing.

 

*p.s., There is a great related post from Nick Mehta that includes this sentence:  “So have a stiff drink, open your eyes and accept that [the new world of SaaS] is harder. This is the new world, and as long as we live in it, we need to embrace it. And, as Lorde would say, we can keep driving Larry Ellison’s yacht in our dreams.”

 

Notes:

Academy of Achievement – Interview: Larry Ellison

Smithsonian Institution – Oral History: Lawrence Ellison

Forbes – Lunching With Larry

SFGate – Larry Ellison, On the Record

CNet – Ellison Nails Cloud Computing

 

A Dozen Things I’ve Learned From Henry Singleton About Value Investing & Venture Capital

William Thorndike (author of The Outsiders) said in an interview that Henry Singleton: “was a MIT trained mathematician and engineer, he got a Ph.D. In electrical engineering from MIT. While he was there he programed the first computer on the MIT campus, and he proceeded to have a very successful career in science. He developed an inertial guidance system for Litton Industries that’s still in use in commercial and military aircraft. He did a whole range of things. And then later in his career– in his mid-40s, he became the CEO of a ’60s era conglomerate called Teledyne.” Henry Singleton was also a limited partner in the pioneering venture capital firm Davis and Rock, and invested $100,000 in Apple in 1978.

Understanding Henry Singleton is worthwhile no matter your investing style, but that is especially true if you are a value investor or a venture investor. As an example of the esteem in which he is held by value investors, Warren Buffett once said: “Henry Singleton of Teledyne has the best operating and capital deployment record in American business.” In his book the Money Masters, John Train writes that Buffett once said this about Singleton: “According to Buffett, if one took the top 100 business school graduates and made a composite of their triumphs, their record would not be as good as that of Singleton, who incidentally was trained as a scientist, not an MBA. The failure of business schools to study men like Singleton is a crime. Instead, they insist on holding up as models executives cut from a McKinsey & Company cookie cutter.

On the venture investing side, Arthur Rock once said: “Henry Singleton was this very brilliant, intellectual type who could foresee all these problems that no one else could see, and he saw opportunities. Henry was as intellectual as anyone I had come across.

Coming up with 12 quotations in this case was not easy since Henry Singleton was a very private individual. If you go looking for quotations from Henry Singleton, you will not find much more than is set out below.

1. “I don’t believe all this nonsense about market timing.” Singleton was not someone who thought he could profit from timing the market in the short term. Because of his aversion to market timing, Singleton believed that making precise predictions about the short-term direction of markets was neither possible nor necessary, if you understand value and have the discipline to invest aggressively when the time is right. Following this approach, Henry Singleton was able to accumulate one of the best capital allocation records of any investor ever. He generated a 20.4% compound annual return for shareholders over 27 years. Charlie Munger has said Singleton’s financial returns as an investor were a “mile higher than anyone else …utterly ridiculous.”

 

2.“My only plan is to keep coming to work every day. I like to steer the boat each day rather than plan ahead way into the future.” “I know a lot of people have very strong and definite plans that they’ve worked out on all kinds of things, but we’re subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.” Henry Singleton was also someone who understood the value of optionality. Singleton was able to put himself in a position to opportunistically capture profits when assets were mispriced. They key to optionality is simple: bet big when you have a big upside and a small downside. When you have a big downside and a small upside, don’t bet. If you have a big upside and a big downside, why bet if other bets have more valuable optionality?

3. “It’s good to buy a large company with fine businesses when the price is beaten down over worry..” Buying shares in a business with a moat at a price that is beaten down is the value investor’s mantra. Prices get beaten down when there is a lot of uncertainty caused by worry. Be greedy when others are fearful. John Train points out that Singleton bought over 130 business “when his stock was riding high, then when the market, and his stock fell, he reversed field.”

Singleton used big stock price drops to aggressively buy back Teledyne shares. Mike Milken describes one of Singleton’s business decisions here: “In the 1970s two businessmen I greatly admired were doing what Drexel and its clients and its imitators were doing ten years later: using debt–junk, if you will–to acquire equity. I’m talking about Dr. Henry Singleton of Teledyne and [the late] Charles Tandy of Tandy Corp. These were both great operational managers and great financial managers. They recognized that their common stock was selling at ridiculously low levels, so they offered to swap high-coupon bonds for common stock. Tandy used $35 million in 10% 20-year bonds to acquire 11% of its own common. In less than ten years that repurchased stock was worth more than $1 billion. Singleton bought in 26% of Teledyne’s equity for $100 million in 10% bonds–a very high coupon in those days. By the early 1980s that repurchased stock was worth more than $1.5 billion.”

 

4. “There are tremendous values in the stock market, but in buying stocks, not entire companies. Buying companies tends to raise the purchase price too high.” “Tendering at the premiums required today would hurt, not help, our return on equity, so we won’t do it.” Henry Singleton did not like paying a control premium. If you are paying a control premium, you are counting on the fact that you will be able to change the operations or strategy of that business AND realize that value, in addition to the right return on investment on that premium. With control you do have the ability to change strategy, benefit from supply or demand side economies of scale or scope, lower the cost structure of the business, sell unattractive assets or obtain tax benefits.

 

5. “After we acquired a number of businesses we reflected on aspects of business. Our conclusion was that the key was cash flow.” This approach is not dissimilar to Jeff Bezos, John Malone and others who focus on absolute dollar free cash flow rather than reported earnings. Growth of revenue and size of the company were never key financial goals. Singleton liked businesses which generated cash that could either be taken out of the business or reinvested when it makes sense. Reinvesting only make sense when you can generate substantially more than a dollar in value for every dollar reinvested. Some executives like Henry Singleton, John Malone and Warren Buffet know how to redeploy cash, but some don’t.

 

6. “Our attitude toward cash generation and asset management came out of our own thought process. It is not copied.” You don’t outperform a market if you are not occasionally contrarian and right about what you believe on enough occasions. Charlie Munger has said about Henry Singleton: “He was 100% rational, and there are very few CEOs that we can say that about.” Arthur Rock once said about Singleton: ”He really didn’t care what other people thought.” Independence of thought and emotional self-control are the keys to making successful contrarian bets. The other point made here by Singleton is about doing your own thinking and not outsourcing it to consultants and bankers.

 

7. “To sell something to lift the price of the stock is not thinking correctly.” In this quote he was referring to a potential spin off or sale, but he also had strong views on stock buy backs and new stock issuance. Henry Singleton believed that the time to sell a stock is if it is overvalued and the time to buy shares is when they are undervalued. What could be simpler? The purpose of a stock buyback should not be to lift the price of the stock. Thorndike puts it well here: ‘[CEOs] can tap their existing profitability– their existing profits– they can raise equity, or they can sell debt. And there are only five things they can do with it. They can invest in their existing operations, they can make acquisitions, they can pay a dividend, they can pay down debt, and they can repurchase stock. That’s it, those are all the choices. And over long periods of time, those decisions have a significant impact for shareholders.”

 

8. “We build for the long term.” Appeasing analysts who cry out for accounting earnings or other concocted metrics in the short term is folly. When his stock went down, Henry Singleton bought more back. That’s an example of long-term thinking. Being fearful simply because others are fearful is a big mistake. The greatest investing opportunity arises when people are fearful.

 

9. “All new projects should return at least 20% on total assets.” Free cash flow was not the only driving metric for Henry Singleton. He believed that businesses with sustained returns on assets (lasting for years, not months) produce superior investment returns. This sustained high return is what investors Warren Buffett and Charlie Munger mean by the “quality” of a stock. This rate of return must be maintained over a period of years to be considered a positive investment criteria, since otherwise you can’t tell whether there is a genuine moat versus merely high points in a business cycle.

 

10. “Our quarterly earnings will jiggle.” Henry Singleton was not someone who managed earnings. Singleton would much rather have had a long term average financial return of 14% that was lumpy than a 12% return that was smooth. Sergey Brin and Larry Page of Google (executives and co-founders) once wrote: “In Warren Buffett’s words, ‘We won’t ‘smooth’ quarterly or annual results.’ If earnings figures are lumpy when they reach headquarters, they will be lumpy when they reach you.”

 

11. “Teledyne is like a living plant with our companies as the different branches and each one is putting out new branches and growing, so no one is too significant.” If Singleton is criticized it is because he operated “a conglomerate.” Warren Buffett disagreed with this criticism: “Breaking up Teledyne was a poor result, certainly now and in the future.” Singleton was able to ignore the criticism since he has the discipline to think and act independently.  It is one thing to talk about being a contrarian and quite another thing to actually do it.  Singleton once said in an interview with Forbes: “being a conglomerate is neither a plus nor a minus.”

“There was no general theme,” Rock has said. “This was a conglomerate of scientific companies, and most of these were allowed to operate with very little direction from corporate.”

While Singleton diversified the businesses of his conglomerate, in terms of his outside investments, Singleton was a “focus” investor who did not believe indexing made any sense for an investor like him. Charlie Munger said Singleton “bought only a few things he understood well” – an approach he shared with famous investor Phil Fisher. Singleton said in his Forbes interview: “the idea of indexing isn’t something I believe in or follow.”

Of course, Singleton was not an ordinary investor.  Singleton was one of the few investors who, as Warren Buffett says, fits into the “know something” category.  Most people are better off with an index-based approach to investing since they do to have the temperament nor the inclination to work as hard as Singleton did to understand the businesses that he was investing in.

 

12. “A steel company might think it is competing with other steel companies. But we are competing with all other companies.” Henry Singleton knew that any moat is subject to attack and that that attack does not need to come from a competitor that is engaged in the same activities. The most successful attacks on a business tend to be asymmetric. Businesses tend to fail not from a frontal attack, but when they are eclipsed or enveloped.

p.s., This interview with Will Thorndike is an outstanding way to understand Singleton.  Thorndike points out in the interview: “Throughout that decade, his stock traded at an average P/E north of 20, and he was buying businesses at a typical P/E of 12. So it was a highly accretive activity for his shareholders. That was Phase One. Then he abruptly stops acquiring when the P/E on his stock falls at the very end of the decade, 1969, and focuses on optimizing operations.

He pokes his head up in the early ‘70s and all of a sudden his stock is trading in the mid single digits on a P/E basis, and he begins a series of significant stock repurchases. Starting in ‘72, going to ’84, across eight significant tender offers, he buys in 90% of his shares. So he’s sort of the unparalleled repurchase champion.”

 

Notes:

If you read anything in the notes below, read the Forbes interview with Singleton.

Forbes – The Singular Henry Singleton 
Amazon – The Outsiders (William Thorndike)Ideas for Intelligent Investing – ‘The Master of Capital

Allocation, Henry Singleton’
Investor’s Business Daily – How Singleton Built An Empire
Manual of Ideas – Teledyne’s Takeoff
NY Times – Henry Singleton Obituary
Berkshire Hathaway Chairman’s Letter – 1981
NY Times – Wall St. Eyes Are On Teledyne
Manual of Ideas – Strategy vs. tactics from a venture capitalist 
Harvard Business Review – How Unusual CEOs Drive Value
Forbes – Mike Milken Interview

A Dozen Things I’ve Learned from John Malone

 1. “The question is: Is the cable business going be a great business; who is going to make the money? It may well be that the Disneys of the world make the money and cable and video continue to get squeezed. But I think at least for now they’ve got enough pricing power in broadband to make up for that.” “They key to future profitability and success in the cable business will be the ability to control programming costs through the leverage of size.” No one has taught me more about transfer pricing than John Malone and the people who work for him. I was lucky enough to work for Craig McCaw who started in the cable TV business before he became a pioneer in cellular communications and interacted with John Malone, TCI and Liberty over the years.

The takeaway from this quote is simple: every business has a value chain and profit pools. How profit is allocated between the layers in the value chain is determined by the relative transfer pricing power of the layers. Lots of businesses create value, but no profit. This fact is poorly understood. The profitability of an industry not the same issues as its importance. As an example, airlines create huge value for society (consumer surplus) but generate very little profit (producer surplus).

 

2. “[Don’t] expose yourself to one financial source.. diversification of every kind.. isolation of financial risk..” The best way to combat the wholesale pricing power of a supplier or customer is to have alternatives. As an example, the cable industry would never rely on a single supplier of a hardware component for that reason. The second point John Malone makes is that creating watertight compartments in a ship (and in a business) to isolate risk is just good engineering.

 

3. “[The sort of ] business that investors want today [is] predictable. It’s got glue, sustainable revenue streams, …meaningful growth and pricing power in parts of the business.” John Malone likes a strong economic moat. The test for whether a moat exists is whether the business has “pricing power.” Warren Buffett puts it this way: If you must hold a prayer meeting to raise prices, you don’t have much of a moat. What happens when you don’t have a moat? Here’s John Malone with an example: “The fiber business is a good business—for one or two providers—but for thirty? All funded with borrowed money? …(I’ll repeat,) great business for one or two providers. Questionable business for six, especially when it’s financed with a bunch of bonds.” I lived this one up close and personal with a portfolio company known as NextLink/XO and know all too well that huge increases in supply when there are many providers is not good for profits. Some people during the bubble thought the Internet had suspended the laws of supply and demand, but they were proven wrong.

 

4. The concept that cable television looked more like real estate than it did manufacturing was always obvious, … to me, anyway. And I think the financial markets really didn’t have a model for cable, because the industry was a small, startup industry with no real following. Coming out of that period of the ’70s, the industry needed some model, some metric how the market could value us. We decided out …to go on a cash flow metric very much like real estate. Levered cash flow growth became the mantra out here. A number of our eastern competitors early on were still large industrial companies — Westinghouse, GE, — and they were on an earnings metric.”

“It’s not about earnings, it’s about wealth creation and levered cash-flow growth. Tell them you don’t care about earnings..” “The first thing you do is make sure you have enough juice to survive and you don’t have any credit issues that are going to bite you in the near term, and that you’ve thought about how you manage your way through those issues.”

“I used to go to shareholder meetings and someone would ask about earnings, and I’d say, ‘I think you’re in the wrong meeting.’ That’s the wrong metric. In fact, in the cable industry, if you start generating earnings that means you’ve stopped growing and the government is now participating in what otherwise should be your growth metric.” Among the many lessons I have learned about finance are as follows: (1) accounting earnings are an opinion; (2) free cash flow is a fact and (3) the only unforgivable sin in business is to run out of cash.  A key figure for John Malone in terms of raising the necessary cash was Michael Milken, who was also a key figure for many other people in this business world like Bill McGowan (MCI Communications), Bob Toll (Toll Brothers), Steve Wynn (Wynn Resorts), Steve Ross (Time Warner), Rupert Murdoch (News Corporation), Craig McCaw (McCaw Cellular, Nextel), and Ted Turner (CNN).

 

5. “Our skills here, internally, are very much in financial engineering.” “Entrepreneurs will always be able to take an asset, leverage it up, operate it tightly and make it worth money to them and get good equity returns.” “You can borrow money against a growing cash-flow stream, and as long as your growth rate’s faster than your cost of money it’s a wonderful business.” 

“The cable industry created so many rich guys. It was the combination of tax-sheltered cash-flow growth that was, in effect, growing faster than the interest rate under which you could borrow money.” “Inflation lets you raise your rates and devalue your liabilities.” How can I say this better than John Malone? I can’t. So I will leave it at that.

 

6. “[Taxes are] a leakage of economic value. And, to the degree it can be deferred, you get to continue to invest that component on behalf of the government. You know, there’s an old saying that the government is your partner from birth, but they don’t get to come to all the meetings.” “Better to pay interest than taxes.” John Malone is a master of deferring taxes. In this video lecture John Malone explains the difference between tax avoidance and tax evasion. What John Malone said he wants to do is make sure that Uncle Sam does not collected his taxes too early. Deferring taxes allows the value of the shares to compound pre-tax. In the video he also talks about how debt, which has interest that is tax deductible, creates significant tax advantages versus equity.

Warren Buffett and Jeff Bezos defer taxes too. Here’s Charlie Munger on this point: “If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15%, or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.”

 

7. “Just like making movies. God help us if we think we can pick winners and losers when it comes to making movies. Even the good guys don’t know how to do that. There are certain fields, in my experience, that it’s good to stay out of. One can be a good investor in them, if one’s prudent, but one shouldn’t fool oneself into thinking one knows how it really works.” This quotation is all about staying within a circle of competence and avoiding hard problems. One excellent way to avoid problems is quite simple: understand that people who know what they are doing make fewer mistakes.  Hollywood is a particularly troublesome place to try to make money if you are not an insider. Cash travels into Hollywood from outside investors, but rarely comes out. You sometimes read about a hit movie, but rarely the failures (which causes survivor bias and investor dysfunction).

 

8. “Recently somebody said, ‘Hey, you lost weight,’ and I said, ‘Yeah, thirty-five pounds and three and a half billion dollars’.” “I’ve done lots of bad deals… Yeah, I’ve done some horrific deals.” “When I stick to my knitting I do okay. It’s – it’s when I listen to some pied piper.” John Malone is talking about the Internet bubble in this quote, when he refers to the money he lost. It was a very crazy time. The level of fear of missing out (FOMO) is hard to convey to someone who did not go through it.

Valuations were nutty. John Malone once called AOL “a big puff bag.. it didn’t have any real assets. A lot of the revenue AOL was reporting as recurring even though it was one time.” Lots of paper wealth was created, which over a very short period of time quickly evaporated. The speed at which the bubble was destroyed was stunning. One month it was possible to raise billions of dollars in cash and the next month you could not raise 5 cents.

 

9. “Don’t ever bid against Rupert Murdoch for anything Rupert wants, because if you win you lose. You will have paid way too much.” Warren Buffett’s advice about auctions is simple: Don’t go. A lollapalooza of psychological factors causes people’s minds to turn to mush at auctions. When it is a charity auction, that dynamic is all good. But in business, auctions can create huge problems – especially if you are bidding against Rupert Murdoch. I heard a famous billionaire once say that no other billionaire scares other billionaires more than Rupert Murdoch.

 

10. “You just have to be opportunistic, and try to figure out what creates value—where the bottom is, what creates incremental value, and in what combinations.” This quote is about optionality. Rather than trying to predict what is going to happen, it is a far more effective to be in a position to capitalize on something that unexpectedly happens. One reason John Malone is so successful is that he has what Greg Maffei has called a “frictionless mind.” What Greg Maffei means is John Malone’s mind can turn on a dime as opportunities change.

As an aside, many of these opportunities John Malone benefited from over the years were acquisitions. John Malone believes the nature of vertical and horizontal acquisitions are very different and that “a lot of mergers fail for cultural reasons.  Vertical acquisitions are much tougher than horizontal ones. You are essentially buying a business you don’t know and you don’t understand.”

 

11. “You’ve got to play both offense and defense.” Watching John position himself in his competition with Murdoch was fascinating. As much as John Malone wants to avoid having single a supplier or customer, he would want to be one if he could. That set off interesting bidding wars in the industries that he is involved in. His battles with people like Rupert Murdoch are fascinating to watch. Because I worked for Craig McCaw at the time, I had a ringside seat during the battle of what was known as “the death star”. John Malone described it this way: “We persisted with PrimeStar right up to the point where our license to buy a high-speed satellite – our joint venture with Rupert Murdoch to use his license – was shot down by the government. So we persisted all the way through and ultimately sold PrimeStar to DirectTV – broke my heart.”

 

12. “Broke my heart to do the AT&T deal. When you’re the controlling shareholder and somebody comes along and offers you a 40-percent premium to a record high stock price, really full valuation, and to a liquid security, you just can’t turn it down. In retrospect, I wish I hadn’t done it.” Sometimes you need to sell a business for one reason or another and its breaks your heart to do so. McCaw Cellular was such a situation.  I do still wish McCaw Cellular had not been sold to AT&T. It was a great business that accomplished great things.

 

Notes:

Mavericks Lecture (video)

Biz Journals – John Malone talks of his past and future  

 

Ken Auletta – A Conversation with John Malone

Tycoon Playbook – The Cable Cowboy

 

Broadcasting Cable – Malone Again

Multichannel.com – Unleashing Liberty

 CNBC – John Malone Interview

A Dozen Things I’ve Learned From Chris Sacca About Venture Capital

1. “Capital just isn’t that important to the early triumph of a company anymore. Much more vital in those inaugural days is collaborating side by side with a founding team that controls its own destiny. Entrepreneurs who are empowered by seasoned advisors, but free to frame achievement for themselves, are much happier.” “When you’re just getting started, I’m the guy you want in your room to help design your product, build the funnel to convert, help you recruit your first couple of employees, get that shit done.” Not all investors are created equal. The winners are persistently the same relatively small groups of investors time after time.  Success not only has positive signaling effects in attracting the factors that drive success, but also talent enhancing effects for the venture capitalists themselves.

In short, the best talent, investors and partners are attracted to each other in ways that are self-reinforcing. By getting to work more with other great talent, investors like Chris Sacca actually become more talented and attract more talented people [repeat]. This is an example of what is known as “cumulative advantage.” If you genuinely have a great idea for a business that has the necessary tape measure home run potential payoff, talent is a far greater constraining resource than money. Getting access is the best investors is not only valuable but essential. What is the biggest startup success you see out there today that was financially backed by no one you have ever heard of?

 

2. “The founder needs someone to bring their A-game to. I did the analysis across my portfolio actually, and the companies I have, those that had leaderless seed-rounds underperformed.” “I think it’s important for anybody to have to sit down, put together a deck, and bring their A game to somebody else, who’s gonna listen. A coach, somebody, you feel accountable to.” “My job is to obsolete myself by series B.” “It’s all fun and games until you raise a Series B.”  People often find a niche where they are most effective and Chris Sacca is telling you where he feels he is most effective and having the most fun. Having a lead investor in a seed round who adds value is really important. If you are raising early stage money and the money is just money, you are settling for less. If you meet a founder and he or she says that all the investors added was money, they may have had a decent financial exit but they almost never hit a tape measure home run.

 

3. “Good investors are in the service business.”  “There are angels who have 75 companies and don’t call any of them ever.” The difference between Chris Sacca and a dentist who writes seed stage checks is measured in light years. Someone like Chris Sacca hustles on behalf of the portfolio company, has judgment and a network of people who know how to get things done. That they are both called Angels by some people seems wrong to me. Great seed stage/early stage venture capital investors are not a common phenomenon.

 

4. “I was involved in a company, where Bill Gurley is an investor and the company was thinking about hiring CFO, and Bill opens up his folder, and he’s got six CFOs, ready to go.  People of public company quality. I thought, ‘I don’t know six public company CFOs in the world.'” “Bill Gurley, will never take credit for that.” When a company gets to a Series A investment round or greater, a business increasingly needs a new set of resources if it is going to scale. Trains need to run on time. Systems must be built. New types of things need to get done. New VCs with new skills often arrive after the seed and A rounds and new management and talent starts to appear. People like Bill Gurley and Chris Sacca have a symbiotic relationship. Sacca is saying that by the time the B round happens he is ready to hand over his active/lead investor role to others. Knowing your highest and best use and what makes you happy is an important life skill.

 

5. “As investors, VCs are wrong more often, than we are right.” “As a VC, I’m wrong most of the time, so whenever any of the VCs tell you about the rules etc. it’s really, because we’re wrong all the time. You should expect me to be wrong most of the time. When I’m right, I’m really really right. That’s what you should expect from a VC.” Being a VC is all about hitting tape measure home runs.  You can be wrong often. In fact you can be wrong most of the time as long as you are very very right sometimes. It is magnitude of success that matters, not frequency. This is called “the Babe Ruth effect” which I have written about before.

 

6. “Any VC will tell you where they really make their money is on following on, it’s on doubling down into the winners. The things that are growing geometrically in terms of users, revenue that kind of stuff.” As the timeline of a business moves along, phenomena start to emerge from the nest of complex adaptive systems that is an economy or a market.  Spotting the emergence of a potential unicorn causes the best venture capitalists to double, triple or more down on their best bets. They didn’t necessarily see it coming when they did their first investment but later on, they know it when they see it. What was originally optionality over time starts to look more and more like inevitability.

 

7. “I do try to focus a lot on the entrepreneur as a person, I think that has fallen out of the equation recently…. look for driven people.” Getting a company through adversity and challenges takes someone who is driven to succeed. This is why venture capitalists prefer missionary founders to mercenary founders. They also know that strong founders and strong teams are their own form of optionality since they can adapt as the environment changes and opportunities arise.

 

8. “Companies don’t succeed, when there’s a lot of chiefs and no Indians.” Someone needs to do the work. In fact, everyone needs to do the work.  Startups with poseurs don’t survive. Public relations and hype only get you so far and if the founders start believing the PR you can put a fork in the business. It is done.

 

9. “Once you have FOMO (fear of missing out) on your side, you no longer have to ask people like [me] for money. They’re lining up to give it to you.” When doubt or uncertainty exist, people tend to follow other people. For this reason, if you can get a great lead investor getting each additional investors get vastly easier. The process can become like a snowball running downhill. That can have good results and bad. In the Internet bubble, Pets.com was the poster child for FOMO. Today Clinkle would be an example of FOMO creating big problems for investors.

 

10. “Create value before you ask for value back.” This is a fundamental principle of networking.  Chris Sacca shares this view with Heidi Roizen, who I wrote about here.

 

11. “Simplicity is hard to build, easy to use, and hard to charge for.  Complexity is easy to build, hard to use, and easy to charge for.” What Chris Sacca talks about here is why there is such a premium on design these days in venture capital. This, in no small part, helps explain the mass migration of companies up into San Francisco from the peninsula (designers are often allergic to suburbs).  As the great Startup L. Jackson once said: “Y’all talk about UX like it’s just another feature. For a user, it literally is the product. Full stop. Everything else is inside baseball.”

 

12. “It’s people with these broader life experiences who have balanced relationships who come up with the cool shit.” “College done right, particularly like a liberal arts school, is a lot less about the individual facts. You learn more about how to think, how to communicate, experimenting with personal boundaries, drinking too much, taking the time to go abroad.” This is straight up consistent with the Charlie Munger view that you need to have a latticework of different models to make good decisions. People who only know one or even a few models have “person with a hammer syndrome.” They have their one model and everything to them looks like nail for that model. A broad liberal arts education helps you become wise. Wisdom is a highly underrated skill.

A Dozen Things I’ve Learned From Steve Blank About Startups

1. “A startup is a temporary organization designed to search for a repeatable and scalable business model.” Any analysis of this statement should start with a definition of “business model.” I like the Mike Maples, Jr. definition: “The way that a business converts innovation into economic value.” Steve Blank has his own definition: “A business model describes how your company creates, delivers and captures value.”  One very effective way to find a business model is to apply a trial and error process in which the optimal result is discovered via experimentation rather than a grand plan generated at once from whole cloth. As I pointed out in my Eric Ries/Lean Startup post, others believe the truly big and important business models can’t be discovered incrementally.  Applying the scientific method to the business model discovery process can be very valuable. It is not the only useful model for creating a business model, but it is an important one.

 

2. “A company is a permanent organization designed to execute a repeatable and scalable business model.” “Large companies are large because they found a repeatable business model and they spend most of their energy executing – meaning doing the same thing over and over again. They figured out what the secret is to growing their business.”  An established business that has existing systems and procedures developed to execute on a known business model can, if it is not careful, generate antibodies which stifle the development of new products and services as well as new business models. There is an inherent tension between creating a new repeatable and scalable business model and optimal execution, since great execution often involves eliminating anything that is not core to that mission.

 

3. “Business plans are the tools existing companies use for execution. They are the wrong tool to search for a business model.” “Startups are not smaller versions of larger companies. There are something very different. So, I asked ‘Why are you teaching us to write business plans? Business plans are operating plans. and we don’t even know what it is we are supposed to be operating.’ A business plan is the last thing you want a startup to write, yet we’re still not only requiring it for small businesses, we won’t fund you without one.

“A business plan is exactly like telling you to go boil water when someone’s having a baby: it’s to keep you busy, but there’s no correlation between success and your activity.”  “The unique people who need a 5-year business plan are VCs and Soviet Union.”

“In a startup, no business plan survives first contact with customers.” The operative word in this series of Steve Blank quotes on business plans is “search.” You can describe your ‘planned search process’ when you are creating a startup, but trying to describe the result of your search before it happens is a useless exercise. The world is changing so quickly and there is so much uncertainty that writing out a long-term business plan is essentially a work of fiction and a waste of precious time and resources.

 

4. “A startup is not about executing a series of knowns. Most startups are facing a series of unknowns—unknown customer segments, unknown customer needs, unknown product feature set, etc.” “A pessimist sees danger in every opportunity but an optimist sees opportunity in every danger.”  The biggest financial returns are harvested when uncertainty is the greatest, since that is when assets have a much more significant tendency to be mispriced. I have written a post on optionality and venture capital which directly addresses what Steve Blank is talking about.  Making decisions in life and in business is a probabilistic activity.  We all face:

  1. Risk: future states of the world known, and probabilities of those future states known (e.g., roulette).
  2. Uncertainty: future states of the world known, but probabilities of those future states are not known (i.e., most things in life).
  3. Ignorance:  future states of the world unknown, probabilities therefore not computable (i.e., black swans).

The best way to deal with this reality is to apply the following four-step process like Howard Marks:

  1. “The future should be viewed not as a fixed outcome that’s destined to happen and capable of being predicted, but as a range of possibilities and, hopefully on the basis of insight into their respective likelihoods, as a probability  distribution;”
  2. “Risk means more things can happen than will happen;”
  3. “Knowing the probabilities doesn’t mean you know what’s going to happen;” and,
  4. “Even though many things can happen, only one will.”

Howard Marks goes on to say: “since future events can’t be predicted, risk can’t be qualified with precision.” One can deal with this by having a probabilistic approach to life, focusing on having sound processes and thinking long-term.

For a founder or investor who can remain rational this uncertainty is a huge opportunity, since this is what causes assets and opportunities to be mispriced. It was precisely when the economy was at its low point after the recent financial crisis that the times of greatest opportunity existing for an investor or founder.  In other words, the best time to found a company is in a downturn. Employees are easier to recruit, resources less expensive, and competition less intense. It takes courage to do this, but that courage can pay big dividends. Optimists and people who have been through previous business cycles are much more likely to realize that things inevitably get better.

 

5. “Products developed with senior management out in front of customers early and often – win. Products handed off to a sales and marketing organization that has only been tangentially involved in the new product development process lose. It’s that simple.”

“The reality for most companies today is that existing product introduction methodologies are focused on activities that go on inside a company[‘s] own building. While customer input may be a checkpoint or ‘gate’ in the process it doesn’t drive it.” “There are no facts inside the building so get the hell outside.”  Nothing drives the customer development process forward more than time spent with actual customers. The best founders, CEOs and senior managers spend huge amounts of time with customers. It is not an activity they delegate. This inevitably happens because they love the product and services and want to share this love with others.  This is a large part of why missionary founders do better than mercenary founders. Passion of founders and employees pays dividends that compound for the startup.

 

6. “This whole lean stuff actually works best if you’ve failed once. If you’ve failed once, you’d really appreciate the value of not just following your passion, but maybe devoting 10 percent to testing your passion before you commit three to four years of your life to it.” Good judgment tends to come from experiencing bad judgment either on a first party or third party basis. Nothing is more precious than time, and time spent early in the process figuring out whether the dogs will eat the dog food is priceless. There is no sense following your passion right off a cliff if a relatively small effort devoted to testing can keep you from that fate.  Better yet, that experimentation may allow you to discover a vastly better way forward that does not involve a journey off that cliff.

 

7. “’Build it and they will come,’ is not a strategy; it’s a prayer.” “Using the Product Development Waterfall diagram for Customer Development activities is like using a clock to tell the temperature. They both measure something, but not the thing you wanted.” The traditional product development process is described as a “waterfall” since the intent is to have progress flow down from step by step over time.

 

Waterfall Model

Source: Wikipedia

 

The syllabus of Eric Ries’s Udemy class on Lean Startup contrasts the approaches:

“Waterfall – the linear path of product build-out – is best used when the problem and its solutions are well-understood. However, its hazard is that it can also lead to tremendous investment without guarantee of its success. Agile development, on the other hand, is a less-risky model of what can happen when the product changes with frequent user feedback and minimal waste. Without an authoritative solution clearly in sight, which is often the case of the startup, agile programming allows the growing enterprise to build-out quickly and correct itself often.”

 

8. “The company that consistently makes and implements decisions rapidly gains a tremendous, often decisive, competitive advantage.” “What matters is having forward momentum and a tight fact-based data/metrics feedback loop to help you quickly recognize and reverse any incorrect decisions. That’s why startups are agile. By the time a big company gets the committee to organize the subcommittee to pick a meeting date, your startup could have made 20 decisions, reversed five of them and implemented the fifteen that worked.” The companies that survive in a rapidly evolving environment are those that are most agile. The Lean movement and agile development generally reference using a process of continuous experimentation and feedback from the results of those experiments to stay on top of changes.

Nassim Taleb describes this approach in this passage from Antifragile:  “Any trial and error can be seen as the expression of an option, so long as one is capable of identifying a favorable result and exploiting it…” and “Someone who, unlike a tourist, makes a decision opportunistically at every step to revise his schedule (or his destination) so he can imbibe things based on new information obtained. In research and entrepreneurship, being a flaneur is called “looking for optionality.”

 

9. “Founders see a vision but then they manage to attract of a set of world-class employees to help them create that vision.” A founder who will succeed at creating a startup must be able to sell, and a very early test of that skill is his or her ability to recruit a team. Convincing world class people to join something with as much uncertainty attached to it as a startup is a genuinely valuable skill.  The best venture capitalists know that the first hires are critical so they will often help with recruiting especially at that stage. It is not uncommon for a founder to spend 25% or more of the their time recruiting the team that will ultimately drive the startup forward.

 

10. “You don’t have to be the smartest person, but showing up is 80% of the game. My career has been all about just showing up and people saying, ‘Who’s here? Blank is here. Let’s pick him.’ Volunteering and showing up has been a great thing for me. But all along the way, I’ve always been very good at pattern recognition. Picking signal out of noise. Not smarter than everyone else, but more competent perhaps at seeing patterns.” Things like being on time, being there when leaders and teams are chosen, and developing sound judgment, are the blocking and tackling of the startup/business world. Woody Allen once wrote in a letter: “My observation was that once a person actually completed a play or a novel, he was well on his way to getting it produced or published, as opposed to a vast majority of people who tell me their ambition is to write, but who strike out on the very first level and indeed never write the play or book. In the midst of the conversation, as I’m now trying to recall, I did say that 80 percent of success is showing up.” To create a startup or a new line of business you must first start. As an example, the way I wrote my first book was that I started writing. I didn’t know anything about book proposals, agents or the sometimes strange ways of the publishing world.  I just wrote a book and sent it to a publisher and they published it. What I did is not a process I would recommend now that I know more about the industry, but at least I started. By writing the book I “showed up.” Each weekend when a 25IQ “12 things” blog post appears, I “show up.”

 

11. “Upper management needs to understand that a new division pursuing disruptive innovation is not the same as a division adding a new version of an established product. Rather, it is an organization searching for a business model (inside a company that’s executing an existing one.)  When you’re doing disruptive innovation in a multi-billion dollar company, a $10 million/year new product line doesn’t even move the needle. So to get new divisions launched, large optimistic forecasts are the norm.

Ironically, one of the greatest risks in large companies is high pressure expectations to make these first pass forecasts that subvert an honest Customer Development process. The temptation is to transform the vision of a large market into a solid corporate revenue forecast – before Customer Development even begins.” People spend a lot of time at large companies coming up with optimistic market forecasts. They are often created using methods pioneered by Professor “Rosy Scenario.” Market research firms make a nice living supplying these forecasts. Lots of forecasts about the future have zero tie to reality. They are little more than imaginative story telling trying to convince people that an area with some optionality has promise. I like stories. Stories are very useful and can be fun to tell.  I have published two books of stories that you can buy on Amazon http://www.amazon.com/Ah-Mo-Indian-Legends-Northwest/dp/0888392443/ref=sr_1_1?ie=UTF8&qid=1413604348&sr=8-1&keywords=ah+mo+griffin and http://www.amazon.com/More-Indian-Legends-From-Northwest/dp/0888393032/ref=pd_sim_sbs_b_1?ie=UTF8&refRID=139GKX2N9KC8WDFG2E50 but they are just stories.

 

12. “I said ‘There are 500 people in this room. The good news is, in ten years, there’s two of you who are going to make $100 million dollars. The rest of you, you might as well have been working at Wal-Mart for how much you’re going to make.’ And everybody laughs. And I said, ‘No, no, that’s not the joke. The joke is all of you are looking at the other guys feeling sorry for those poor son-of-a-bitches.’” Financial success in creating and funding startups follows a power law.  This means that a very small number of startup founders, employees and investors will reap most all of the financial rewards.  The overconfidence heuristic will make most everyone overconfident that the winners will include them. The inevitable failures are hard for individuals, but the right thing for society as a whole.

 

Notes:

Entrepreneur in London – Steve Blank

Inc, Entrepreneurship – Six Types of Startups

Reuters – Q&A with Silicon Valley “Godfather” Steve Blank

Philadelphia University – Steve Blanks Commencement Speech

Francisco Palao – Best Quotes from the Lean Start up Conference

Stanford – Four Steps

LogoMaker – Thirteen Inspiring Quotes for Small Business from Steve Blank

A Dozen Things I’ve Learned From Guy Spier About Value Investing

1.“The entire pursuit of value investing requires you to see where the crowd is wrong so that you can profit from their misperceptions.”  A value investor seeks to find a significant gap between the expectations of the market (price) and what is likely to occur (value). To find that gap the value investor must find instances where the crowd is wrong. Michael Mauboussin writes: “the ability to properly read market expectations and anticipate expectations revisions is the springboard for superior returns – long-term returns above an appropriate benchmark. Stock prices express the collective expectations of investors, and changes in these expectations determine your investment success.”

Value investing is buying assets for substantially less than they are worth and, says Seth Klarman “holding them until more of their value is realized.” Klarman describes the value investing process as “buy at a bargain and wait.”  It is critical that the value investor not try to time the market but rather make the market their servant. The market will inevitably give the gift of profit to the value investor, but the specific timing is unknowable in advance. If there is a single reason people do not “get” value investing it is this point. The idea of giving up on trying to time the market is just too hard for some people to conceive. For these people, timing markets is a hammer and everything looks like a nail. That you can determine an asset is mispriced now relative to intrinsic value does not mean you can time when the asset will rise to a price that is at or above its intrinsic value. So value investors wait, rather than try to time markets.

 

2. “When we apply Ben Graham’s maxim that we should treat every equity security as part ownership in a business and think like business owners, we have the right perspective. Most of the answers flow from having that perspective. …thinking like that is not easy…”  When you treat shares of a company as an interest in a business (rather than a piece of paper to be traded based on mob psychology) you naturally think about private market value. Value investors have developed a valuation process for determining private market value that is very rational. The lynchpin of this valuation process is intrinsic value. While the process of determining intrinsic value is fuzzy (since methods slightly vary) that is ok, since the margin of safety can cover up small amounts of fuzziness if the margin of safety is sufficiently large (e.g., 25-30%). Investment firm Euclidean Technologies has articulated some of Buffett’s views on this valuation process:

“Buffett talks about book value as a measure of limited worth when estimating the intrinsic value of a business. After all, book value reveals very little about the operations of a company; it makes no distinction between a pile of cash and a company with productive assets, great products, and loyal customers. Instead, when evaluating intrinsic value, Buffett focuses on understanding the amount of cash that a business can generate and distribute to its owners.  He calls this concept owner-earnings…”  

In calculating a valuation of a business, many people fail to understand that value investing and growth are “joined at the hip.” Value and growth investing are not alternatives, but rather inextricably linked. Here’s Buffett:

“Growth is simply a component–usually a plus, sometimes a minus–in the value equation. Indeed growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years.”

Some of the misunderstanding arises because some (but not all) value investors consider quality as a factor in valuation. Many people assume that looking at quality means a focus on growth, when this is definitely not the case. Quality relates to the ability of the business to generate higher return on invested capital.  In his new book Tobias Carlisle explains the difference:

“Earnings—central to [John Burr] William’s net present value theory—were only useful in context with invested capital. Despite his obvious regard for William’s theory, Buffett could show that two businesses with identical earnings could possess wildly different intrinsic values if different sums of invested capital generated those earnings…. All else being equal, the higher the return on invested capital, the more valuable the business.”  

Here’s Buffett on what drives the quality of a business:

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite – that is, consistently employ ever-greater amounts of capital at very low rates of return.”

Note that the way Buffett measures quality does not refer to reliance on a new growth input and most certainly not any macroeconomic factor. Quality is about relative return on invested capital!

Euclidean Technologies writes on return on capital:

“Buffett cares deeply about the magnitude and resiliency of a company’s long-term return on capital.  Return on capital is simply the relationship between the earnings a company generates and the amount of capital tied up in its business.  For example, a company that can consistently deliver $0.20 for every $1 in capital employed would show a robust 20% return on capital.  To Buffett, this would be a higher quality business than another that delivered a lesser yield or showed deteriorating, or inconsistent, returns on capital.  Moreover, this yield relationship between earnings and invested capital allows Buffett to view a prospective investment in relation to all other potential uses for capital…” 

What determines long-term return on capital? The strength of any barriers to entry (a moat) possessed by the business.  Unless you have a moat your profitability will inevitably suffer as competitors copy your success. If there is no impediment to new supply of what you sell, competition among suppliers will cause price to drop to a point where there is no long term industry profit greater than the cost of capital. (Econ 101)

 

3. “All-too-often, we feel like we are forced to take a decision. Warren Buffett has often said that, unlike baseball, there are no ‘called strikes’ in investing. That is a truism, but the point is that too many of us act like it is not true. Amateur investors, investing their own money, have a huge advantage in this over the professionals. When you are a professional, there is a whole system of oversight that is constantly saying, “What have you done for me lately!” or in baseball terminology, ‘Swing you fool!’”

“Most of the time the answers are not to invest and to do nothing.” 

To profit as a value investor you must:

  1. find an instance where the crowd is wrong,
  2. that gap must be within your circle of competence, and
  3. the value of the asset purchased must substantially exceed the price paid (e.g., 25%), so you have a margin of safety which can allow you to profit even if you make a mistake or suffer from bad luck.

Since these three things happen at the same time only occasionally, most of the time you should do nothing. Since inactivity tends to be contrary to human nature, learning to be patient and yet aggressive when the time is right is a trained response.  This is part of the reason why value investing is simple, but not easy.

 

4. “I’m trying to manage myself, not just my portfolio.” Most mistakes made by investors are psychological or emotional. The task of managing yourself is all about avoiding those mistakes.  The work required to overcome emotional and psychological mistakes never ends.  You will never stop making some mistakes. But hopefully you can at least learn to mostly make new mistakes and to learn from the mistakes of others.  Paying attention and being a learning machine are essential. People who don’t pay attention are surprisingly common. As Seth Klarman writes in his book, Margin of Safety: “The greatest challenge for value investors is maintaining the required discipline.”  As an example, to be a contrarian you must be willing to sometimes be called wrong by the crowd. That will be uncomfortable for most all people.

 

5. “Leverage can prevent you from playing out your hand, because exactly the time when markets go into crisis is when your credit gets called.” Leverage magnifies your mistakes in addition to your successes.  Guy Spier is also saying that it can interfere with your ability to continue investing, since a called loan can take you out of the game. James Montier writes:  “Leverage can’t ever turn a bad investment good, but it can turn a good investment bad. When you are leveraged, you can run into volatility that impairs your ability to stay in an investment – which can result in a permanent loss of capital.”

 

6. “Going forward, a 5% position will be a full position. An idea will have to be something absolutely extraordinary to become a 10% position and many positions in the portfolio are currently 2-4%.” It seems like Guy Spier has moved away from a Phil Fisher/Charlie Munger view on diversification, to something that is closer to what Graham himself believed. At these ownership levels, Spier is not at risk of being a closet indexer and yet he still has a comfortable level of diversification.  His new view on diversification seems consistent with views of Ed Thorp as internalized by Bill Gross and Jeffrey Gundlach.

 

7. “Value investors probably pay far too little attention to the credit cycle. In my case, I think that I was utterly convinced that my stocks were sufficiently cheap, such that I could invest without regard to financial cycles. But I learned my lesson big time in 2008 when I was down a lot. I now subscribe to Grant’s Interest Rate Observer so as to help me track the credit cycle.” Howard Marks has said he watches the business cycle but he has never actually said what he does with what he sees in the cycle. Marks seems to use his view on where the business cycle may be as a signal to raise more cash or send it back to his limited partners. Guy Spier seems to be saying he treats the credit cycle as a factor, in some unquantified way. I find myself increasing cash gradually as markets reach prices that are on “the high side of fair,” but I doubt this is based on some rational process and I don’t see any magic formula. Warren Buffett says he never pays attention to macro factors. But he is Warren Buffett and you and I are not. Not everyone has his discipline.

 

8. “I do not use short selling. The fund has not shorted a stock since the 2002 to 2003 time frame. At that time I did short three stocks, on which I broke even on two and made money on one of them. The experience taught me that I was not going to be using short selling going forward for a slew of reasons. The first is the straightforward logic of the matter. The trend of the market is up, not down. Shorting stocks puts you against that trend and thus makes it more difficult to make money. … Second, the mathematics of shorting – when you short something and it goes [against you], it becomes a bigger and bigger part of your portfolio, thus creating increasing risk as things go against you, making it an unbalanced and unstable thing to manage. By contrast, when you go long something and it goes against you, it becomes a smaller and smaller proportion of the portfolio, thus reducing its impact on the portfolio. So there is a tendency for long positions to self-stabilize in a certain way – they have a stabilizing effect on the portfolio, whereas short positions have a destabilizing effect on the portfolio.” Ordinary investors are significantly at risk when they short stocks. When I say something like this, people tend to extrapolate and say that I must favor banning shorting stocks. No, I don’t favor a legal ban. That something is unwise for an ordinary investor does not necessarily mean it should be made illegal. That people like Jim Chanos can (1) profit and (2) perform a socially useful function does not mean an orthodontist or a bricklayer should be shorting stocks.  If Guy Spier, Berkowitz, Pabrai, Buffett and Munger don’t short stocks (since it is “too difficult”) what chance of success does the ordinary investor have?

 

9. “If I’d not fallen under the sway of Warren Buffett, who knows, maybe I’d still be working at some skeezy place and if not committing financial fraud, then at least not serving society very well.” Guy Spier graduated from Harvard Business School and found out too late that he had gone to work for a business with questionable ethics.  Guy Spier credits Buffett and Munger with leading him away from the dark side of Wall Street. This is a good thing. Guy Spier’s publisher describes his book as revealing “his transformation from a Gordon Gekko wannabe, driven by greed, to a sophisticated investor who enjoys success without selling his soul to the highest bidder.”

Spier himself writes: “I think it’s important to discuss just how easy it is for any of us to get caught up in things that might seem unthinkable—to get sucked into the wrong environment and make moral compromises that can tarnish us terribly. We like to think that we change our environment, but the truth is that it changes us. So we have to be extraordinarily careful to choose the right environment—to work with, and even socialize with, the right people. Ideally, we should stick close to people who are better than us so that we can become more like them.”

 

10. “We know in particular that there is a class of investors who get excited about stock splits – even though they do not change the value of the business or achieve anything else substantive. By not catering to that group, Berkshire already makes significant strides in that direction of having a higher quality shareholder base.” “Decentralized organisms are more resilient to having their legs cut off and Berkshire Hathaway is the same way… as opposed to a command and control organization.” Regarding the first point, having better investors is a competitive advantage for a business.  It allows the business to invest for the long term and to be contrarian when it makes sense to be contrarian. Regarding the second point, Nassim Taleb points out:  “In decentralized systems, problems can be solved early and when they are small.” Decentralized systems are more robust to failure. If you ask Buffett how Berkshire ended up this way, he will say that it is just his nature. And of course it has worked very well. Charlie Munger points out that for this approach to work you must have a seamless web of deserved trust in which the decentralized managers are given the freedom to manage what they do and sufficient skin in the game to be properly motivated/aligned.

 

11. “The idea that we are managing some finely tuned machine is just not the case. I’m just trying to get it right. 55% of the time or get it slightly better 55% of the time.”  Guy Spier is pointing out that over time even a modest level of outperformance compounds in a beautiful way, if expenses and costs are kept low. Everyone will make mistakes but if you have a sound investment process you can be way ahead in the game. Mauboussin is the master of this area in my view: “While satisfactory long-term outcomes ultimately define success in probabilistic fields, the best in their class focus on establishing a superior process with the understanding that outcomes take care of themselves.”

 

12. “Mohnish Pabrai taught me to be a cloner. In the academic world, plagiarism is a sin. In business, copying other people’s best ideas is a virtue, and it is no different in investing. I would go further. In the same way that if I wanted to improve my chess, I would study the moves of the grandmasters. If I want to improve my investing, I need to study the moves of the great investors. 13F’s are a great way to do that.” As Charlie Munger likes to say, trying to learn everything yourself on your own from first principles is just too hard and takes too long. Learning from others and then working to extend that is the superior approach. Stand on the shoulders of giants whenever you can, but strive for more.  The other key point about cloning relates to business strategy and the business strategies of businesses that one may choose to invest in. Anything you do in business and investing will be copied and cloned. Continued innovation and adaptation are essential to success.

 

Notes:

The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment

The Manual of Ideas – Interview with Guy Spier

Morningstar – “Don’t Be Your Own Worst Enemy” (video)

Seeking Alpha – The Art of Value Investing

Columbia GSB – Guy Spier: Build your Life in a Way that Suits You

Seeking Alpha – Q&A With Guy Spier Of Aquamarine Capital

Value Walk – Decision-Making for Investors, Michael Mauboussin