Elon Musk is a classic missionary founder who is more interested in changing the world and creating enduring businesses than just the financial rewards that may flow to him from the product or service. Mercenaries may sometimes succeed financially, but they do not bring as much lasting value to their communities. What a city and nation wants in terms of economic development are businesses that produce jobs, innovative products and services, a better quality of life and which add to the tax base over the long term. I would rather have an Expedia, Zillow or Tableau in my community than a startup sold early in its potential life by the founder for tens of millions of dollars or even $1 billion, which then slowly (or quickly) disappears.
To cover the situation where a reader of this blog has been living in a cave, set out below is some background information on Musk before getting to his quotes and my own thoughts:
Elon Musk is a South African-born entrepreneur, engineer, and investor. “Musk became a multimillionaire in his late 20s when he sold his start-up Zip2 to Compaq. He taught himself to program and at 12 he sold a game called Blastar. At age 17, in 1989, he moved to Canada and attended Queen’s University. “In 1992 he move to the US to study business and physics at the University of Pennsylvania. He graduated with an undergraduate degrees in economics and physics.” “In March 1999, Musk co-founded X.com, an online financial services and e-mail payment company, that eventually merged with Confinity, which operated a service called PayPal.” He is the founder, CEO and CTO of SpaceX and the Chief Executive Officer, Product Architect and Chairman of Tesla Motors.
1. “People should be less risk averse when there’s not much at risk.’’ “When something is important enough you do it even if the odds are not in your favor.” Musk’s many successes in business and life are an excellent way to explain: (1) why financial returns from venture capital and research and development follow a power law and (2) why the creation of startups that are tape measure home runs in terms of success is enabled by other startups which fail.
The potential distribution of financial returns from the creation of a new businesses that is “0 to n” is convex. I am not going to go very deep into the nature of convexity because most of my readers will stop reading. If you do get bored anyway skip to number 2 below. In the Notes below, two people write on the nature of convexity:
“In finance, convexity is a broadly understood and non-specific term for nonlinear behavior of the price of an instrument as a function of evolving markets. Oftentimes, financial convexities are associated with some sort of optionality embedded in the instrument.”
“The trouble is that convexity involves a whole bunch of seriously geeky math and computer models and normal people probably don’t want to go there. (I don’t even want to go there.)”
Investments which are instead “1 to n” are not convex. Nassim Taleb writes: “Payoffs from [convex investments like venture capital and] research are from Extremistan; they follow a power-law type of statistical distribution, with big, near-unlimited upside but, because of optionality, limited downside.” In other words, convexity is about bets that reflect an asymmetric possible distribution of outcomes. Taleb writes: “Convexity propositions should be embraced – concave ones, avoided like the plague.” The billionaire investor Sam Zell puts it in more understandable terms for an ordinary investor or business person in this way: “Listen, business is easy. If you’ve got a low downside and a big upside, you go do it. If you’ve got a big downside and a small upside, you run away.”
This matrix below represents my attempt to better explain investments which are convex:
Determining whether rights to a potentially convex investment are available at an attractive price requires expected value thinking. If you overpay for an investment which has convexity you are not making a bet with positive expected value. This is why the best venture capitalists and entrepreneurs like Musk and Jeff Bezos are involved in areas and technologies before they become popular. Once the crowds arrive in a given area of investment an investor must invariably overpay for any investments, competition becomes very significant and potential investments cease to be opportunities and instead become efficient ways to destroy wealth.
When you encounter a convex financial or other opportunity with little downside and very big upside, it is with your circle of competence and it is under-priced, you should bet BIG. If the big convex bet is financial you only need to be right once in a lifetime to be wealthy since it is magnitude of success and not frequency of success that determines the desirability of the result. This is the so-called “Babe Ruth Principle.” When you are looking for convex bets, often the best place to look is in areas where you encounter significant complex adaptive systems. Investing is a probabilistic activity. Areas where financial outcomes can potentially be impacted by positive Black Swans can be significant opportunities.
Convex propositions can be found most anywhere if you know how to look for them and Musk is certainly someone who knows how to find them. Discovering convexity is made easier if you want to do things that are uncommon and bold. The convexity is in a sidecar if you will with people who think big and differently. As an example, going to Mars is very important to Musk. When he and Jeff Bezos started their quest to substantially lower the cost of launch using unconventional methods, the bets were convex. A similar bet would not be nearly as convex now that they have has proven their approaches are viable. This is why venture investors and founders inevitably have both spectacular results and many failures. Taleb writes that the process works: “by negative information, reducing the space of what we do by knowledge of what does not work. For that we need to pay for negative results.” If someone tries to take failure out of the process, innovation will cease. This is why Jeff Bezos recently wrote is a shareholder letter:
“One area where I think we are especially distinctive is failure. I believe we are the best place in the world to fail (we have plenty of practice!), and failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it’s going to work, it’s not an experiment.”
As for assessing the “risk” of failure, Musk talks about in his quotes, how risky is something if you can’t conceive of failing? This passage from Jim Cantrell who was on the SpaceX founding team is enlightening:
“He is by far the single smartest person that I have ever worked with … period. I can’t estimate his IQ but he is very very intelligent. And not the typical egg head kind of smart. He has a real applied mind. He literally sucks the knowledge and experience out of people that he is around. … I am going to suggest that he is successful not because his visions are grand, not because he is extraordinarily smart and not because he works incredibly hard. All of those things are true. The one major important distinction that sets him apart is his inability to consider failure. It simply is not even in his thought process. He cannot conceive of failure and that is truly remarkable. It doesn’t matter if it’s going up against the banking system (Paypal), going up against the entire aerospace industry (SpaceX) or going up against the US auto industry (Tesla). He can’t imagine NOT succeeding and that is a very critical trait that leads him ultimately to success. He and I had very similar upbringings, very similar interests and very similar early histories. He was a bit of a loner and so was I. I recently wrote an op-ed piece for Space News where I also suggest that his ruthlessly efficient way to deploy capital is another great reason for his success. He can almost smell the right way through a problem and he drives his staff and his organization hard to achieve it. The results speak for themselves. …In the end I think that we are seeing a very fundamental shift in the way our world takes on the big challenges facing humanity and Elon’s Way as I call it will be considered the tip of the spear.”
Someone who knows Musk well once told me that to understand Musk you really have to understand how badly he wants to go to Mars. They said they have seen him turn down chances to earn more profit since he believed he could get to Mars faster by doing so. This person said to me: “If you want to predict what Musk will do, ask yourself: Will this help him get to Mars faster?” Existing providers of launch did not think they would encounter anyone who thinks this way. To illustrate this “0 to n” approach to investing and life, it is useful to look at something that Musk recently said:
“Essentially what we’re saying is we’re establishing a cargo route to Mars. It’s a regular cargo route. You can count on it. It’s going happen every 26 months. Like a train leaving the station. And if scientists around the world know that they can count on that, and it’s going to be inexpensive, relatively speaking compared to anything in the past, then they will plan accordingly and come up with a lot of great experiments.”
If someone thinks like Musk or Bezos and they are right about their investments, your competing business that did not make the same bets can be in big trouble. This is what happened to Blackberry. An anecdote about Musk that was recently in a Bloomberg article further illustrates the point:
“For France’s Le Gall, Europe’s contemptuous inability to take Musk seriously dates back years. He remembers a conference in Vietnam about a decade ago where the billionaire “showed up in torn jeans and with a plastic bag. He told us — the chiefs of the three biggest rocket launchers worldwide – ‘I am here and you are dead.’ One of us replied: ‘you talk, we launch.’ Had we known…”
2.”Focus on something that has high value to someone else, be really rigorous in making that assessment, because natural human tendency is wishful thinking.” “Great companies are built on great products.” “There are really two things that have to occur in order for a new technology to be affordable to the mass market. One is you need economies of scale. The other is you need to iterate on the design. You need to go through a few versions.” ‘You’ve got to make sure that whatever you’re doing is a great product or service. It has to be really great. To go back to what I was saying earlier, where if you’re a new company – unless it’s like some new industry or new market that hasn’t – if it’s an untapped market, then you have more ability to – the standard is lower for your product or service, but if you’re entering anything where there’s an existing marketplace, against large entrenched competitors, then your product or service needs to be much better than theirs. It can’t be a little bit better, because then you put yourself in the shoes of the consumer and they say why would you buy it as a consumer. You’re always going to buy the trusted brand unless there’s a big difference. A lot of times an entrepreneur will come up with something that is only slightly better, and it can’t just be slightly better. It’s got to be a lot better.” “If you’re trying to create a company. It’s like baking a cake. You have to have all the ingredients in the right proportion.” There is a lot to unpack in this set of statements by Musk, but fundamental to a successful business is making really great products that people want to buy. Great products in this context means that they are not just a little better than what competitors sell or that people already have, but a lot better. This simple fact seems so obvious, but some people get so caught up in trying to “start a company,” that they don’t pay enough attention to creating the products that define the business. How much better than the offerings of competitors must the product be? There is no formula to determine the correct result, but the answer is “a lot.” The SpaceX example is a quite interesting case to examine this question. Launching payloads into space on rockets has traditionally been thought of as a business that does not result in significantly more demand if there is a price drop. This assumption about price elasticity resulted in the traditional space launch providers deciding to milk their sunk non-recurring engineering and not invest significant amounts in new price reducing innovation. In short, these traditional launch providers believed that a lower prices would not result in more profit so they kept prices flat to increasing. This price elasticity assumption by the incumbents created an opportunity for Musk to innovate by relaxing another assumption which was that reuse of rocket stages was not possible. Musk reasoned that if Columbus and other explorers of his era had been forced to throw away their ships after every voyage not much would have been accomplished. Musk has proven that part of rockets can be reused and that other price reducing innovations are possible. Musk now must demonstrate that more rocket launches will be purchased due to the lower price so as to increase the total addressable market (TAM) for launch. For example, a price drop from $375M to $100 Million for a heavy rocket launcher would be a significant price cut. How many more heavy launches will be generated at the new lower price? No one really knows yet. We can expect Musk to be innovative in looking for ways to increase launch demand. For example, the huge communications satellite constellation Musk has proposed is arguably an example of him looking for ways to create new payloads for SpaceX.
3.”It’s OK to have your eggs in one basket, as long as you control what happens to that basket.” The key word in this quotation is “control.” If you take dependencies on others and you have no alternative supplier (i.e, what Roger Fisher calls no BATNA) the suppliers can block your success. For example, if you build a rocket and you must source your booster from a single supplier, then that supplier controls your fate. This is why Musk prefers to make everything he needs or have multiple suppliers. He does not want to buy components from traditional suppliers of launch who want the price of launch to remain high. This is a set of problems related to what I have called “wholesale transfer pricing” in other posts on this blog. Michael Porter calls it “supplier bargaining power.” Having all your eggs in one basket is a concentrated bet. Warren Buffett has a view on concentrated bets that is similar to Musk. Buffett says:
“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.” “I can’t be involved in 50 or 75 things. That’s a Noah’s Ark way of investing – you end up with a zoo that way. I like to put meaningful amounts of money in a few things.” “We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as ‘the possibility of loss or injury.’”
4. “[Physics is] a good framework for thinking. Boil things down to their fundamental truths and reason up from there.” The famous physicist Richard Feynman is a hero to many people, especially to anyone who likes to think about thinking. Feynman was a great believer is being able to understand each step of the reasoning involved in an idea from first principles. David Goodstein once said to Feynman:
“Dick, explain to me, so that I can understand it, why spin one-half particles obey Fermi-Dirac statistics.” Sizing up his audience perfectly, Feynman said, “I’ll prepare a freshman lecture on it.” But he came back a few days later to say, “I couldn’t do it. I couldn’t reduce it to the freshman level. That means we don’t really understand it.”
Warren Buffet believes the same things about business principles. If you cannot write it down, you have not thought it through. In a previous blog post I compared Feynman to Charlie Munger who also has bottom’s up thinking process. What are the factors that really govern the interests involved, rationally considered? What are the influences where the brain at a subconscious level is automatically forming conclusions that may be dysfunctional or incorrect? Munger’s style is to first assemble all the relevant facts and then apply a rational process to produce an analysis of those facts and an investing thesis. Even if you can’t rely on the same principles as physics in business you can adopt its basic ethos.
5. “Starting a business is not for everyone. Generally, starting a business, I’d say, number one is have a high pain threshold. There’s a friend of mine who’s got a good saying which is that starting a company is like eating glass and staring into the abyss. That’s generally what happens because when you first start a company – there’s lots of optimism and things are great. Happiness at first is high, then you encounter all sorts of issues and happiness will steadily decline, and then you will go through a whole world of hurt, and then eventually, if you succeed – and in most cases you will not succeed. Tesla came very close to failure. If you do succeed, after a long time, you will finally get back to happiness. “ “[Starting a company is like] staring into the face of death. If that sounds appealing, go ahead.” “Persistence is very important. You should not give up unless you are forced to give up.” “You will encounter issues you didn’t expect, step on landmines. It’s bad. Years 2 to 4 or 5 are usually quite difficult. A friend has a saying, it’s ‘eating glass and staring into the abyss’ … “If you’re cofounder or CEO, you have to do all kinds of tasks you might not want to do … If you don’t do your chores, the company won’t succeed … No task is too menial.” Starting a business is as brutally hard as Musk describes. If you like doing things that are brutally hard, and some people do, then you may want to start a business. And if you don’t like doing that, then don’t. It’s that simple. Of course, just liking challenges and hard work is not enough to create success since the founders must have the other required inputs like the necessary skills, significant innovation, a big addressable market and the ability to assemble a great team.
6. “Constantly seek criticism. A well thought-out critique of whatever you’re doing is as valuable as gold, and you should seek that from everyone you can, but particularly your friends. Usually, your friends know what’s wrong, but they don’t want to tell you because they don’t want to hurt you. Yeah, they say I want to encourage my friend so I’m not going to tell him what I think is wrong with his product. It doesn’t mean your friends are right, but very often they are right, and you at least want to listen very carefully to what they say.. and to everyone. You’re looking for, basically, you should take the approach that you’re wrong. That you, the entrepreneur are wrong. Your goal is to be less wrong.” “Pay attention to negative feedback and solicit it, particularly from friends. Hardly anyone does that, and it’s incredibly helpful.” ” It’s very important to have a feedback loop, where you’re constantly thinking about what you’ve done and how you could be doing it better.” “Some people don’t like change but you need to embrace change if the alternative is disaster.” To learn from success or failure you need effective feedback loops. Some people take feedback better than other particularly if it is criticism. Musk and people like him are very thick skinned and have a scientific orientation. The best approach is to have “strong ideas weakly held.” Someone with strong ideas should know the topics well and have researched all side of the issues. By keeping this strong views weakly held the person can adapt as new information and idea arrive. What people struggle with most is learning from mistakes. Charlie Munger has views that are quite similar to Musk on this topic. Munger says: “Why not celebrate stupidities?” “I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.” It is through the process of making mistakes and having success in the real world that you can learn and establish sound business judgment.
7. “Work like hell. I mean you just have to put in 80- to 100-hour weeks every week. [This] improves the odds of success. If other people are putting in 40 hour work weeks and you’re putting in 100 hour work weeks, then even if you’re doing the same thing, you know that you will achieve in four months what it takes them a year to achieve.” The work ethic of Elon Musk is legendary. He has been described at working 15 hours days and sleeping six hours a night. Musk’s ex-wife talks about his work habits this way: “I had friends who complained that their husbands came home at seven or eight. Elon would come home at eleven and work some more. People didn’t always get the sacrifice he made in order to be where he was. He does what he wants, and he is relentless about it. It’s Elon’s world, and the rest of us live in it.” This set of quotes about the value of hard work and working harder than your competitors from Musk makes me think of Michael Mauboussin’s point that if you can work to change the outcome of something what you do to impact that outcome isn’t luck. The cause of that success is instead hard work or skill.
8. “I don’t think it’s a good idea to plan to sell a company.” “My motivation for all my companies has been to be involved in something that I thought would have a significant impact on the world.” As I said above, Musk is the poster child for the value of the missionary as opposed to the mercenary founder. Missionaries are more likely to get through the hard tasks, stress and hardships involved in building a business because they have the drive to succeed. Sometimes a great success is only inches from failure before is eventually breaks through to become a great success. It isn’t easy to have people say you are wrong or even crazy. People say that in the early days of Space X his goal was to “the Southwest Airlines of Space,” which is not the goal of a mercenary, but rather a missionary. Investors who back missionaries instead of a mercenaries are not only doing the right thing for society they will be more successful financially. Missionaries possess the key quality that Taleb describes as follows: “the remarkable ability to engage in rational forms of trial and error, with no comparative shame in failing again, starting again, and repeating failure.”
9. “Any product that needs a manual to work is broken.” I love this quote since I do not like to read manuals. I am glad manuals exist, but they are not my passion. Some people love to read manuals. I am not one of those people. The way great designers and engineers can reduce of eliminate the need for a manual is a beautiful thing to see. Some people seem naturally suited for this work just as they are for understanding what consumers will like and buy. As an example, one of my favorite things in life is to watch my friend Craig McCaw handling a new device. Craig is dyslexic and is someone who does not enjoy reading a manual. That is part of what gives him special insight into the mind of a consumer. He has the best instincts for what consumers will buy that I have ever seen.
10. “If things are not failing, you are not innovating enough.” It takes you very little time reading this blog you know I am fond of the ideas of Charlie Munger. He said once: “There’s no way that you can live an adequate life without many mistakes.” Munger’s partner Warren Buffett agrees: “I make plenty of mistakes and I’ll make plenty more mistakes, too. That’s part of the game. You’ve just got to make sure that the right things overcome the wrong.” As I explain above failure is an essential part of harvesting optionality. It is how we acquire the information necessary to innovate. A system without failure is a system that will not progress. The economist Allan Meltzer created the following aphorism to capture this idea: “Capitalism without failure is like religion without sin. It doesn’t work. Alternatives to capitalism concentrate power in few hands, opening the way to tyranny and brutality, not justice.”
11. “The market is like a manic depressive.” This is so close to the “Mr. Market” metaphor that it is hard to imagine that Musk has not read the work of Ben Graham. He has at least read about the ideas of Warren Buffett who calls Mr. Market “a drunken psycho.” Anyone who thinks the market is always wise is not paying attention. Entrepreneurs and investors like Musk are able to figure out where conventional wisdom is wrong so as to create or purchase under-priced optionality. These entrepreneurs are searching for positive optionality in an environment filled with the mistakes of other people. When the market is depressed is often the best time to invest and start a business. Talent is more available in a downturn if you can find the necessary cash or raise it during good times. This is why venture capitalist Eugene Kleiner once said: “When they are passing the hors d’oeuvres take two.” In achieving his many objectives in recent years Musk has had the good luck to be operating in favorable capital markets. If luck shines on you you for any reason, you should not only take a bow, but take full advantage of it while the sun shines.
12. “I think it matters whether someone has a good heart.” “I don’t believe in process. In fact, when I interview a potential employee and he or she says that ‘it’s all about the process,’ I see that as a bad sign. “The problem is that at a lot of big companies, process becomes a substitute for thinking. You’re encouraged to behave like a little gear in a complex machine. Frankly, it allows you to keep people who aren’t that smart, who aren’t that creative.” Once upon a time, I interviewed with Craig McCaw for a job. I don’t remember much about our conversation specifically other than it was very pleasant and we talked about any things. My favorite memory of that day was speaking to someone after the interview and being told that Craig thought I had: “a good heart.” Just thinking about that feedback makes me smile. More than anyone in my life, Craig McCaw taught me about the value of avoiding conventional thought, action and processes. People who worked at McCaw companies thought of ourselves as pirates and Craig encouraged that approach. Like Musk, McCaw hates process and bureaucracy. The former Bell companies were our competitors and we took pride in operating with unorthodox strategies and tactics when facing them and others as competitors. We were encouraged by Craig’s example to think for ourselves and be creative. In terms of his approach to business, Craig is more like Elon Musk than anyone I know. Their personalities are quite different it seems, but their “I would rather be a pirate than join the Navy” attitude toward business is very similar.
Notes:
Convexity first quote above: https://www.math.nyu.edu/~alberts/spring07/Lecture4.pdf
Convexity second quote above: http://www.calculatedriskblog.com/2008/01/options-theory-and-mortgage-pricing.html#cl1cBzYOySQBWHQs.99
Wired Interview: http://www.wired.com/2012/10/ff-elon-musk-qa/
Dell Keynote, December 12, 2013 http://shitelonsays.com/transcript/opening-keynote-with-michael-dell-and-elon-musk-austin-tx-2013-12-12
PBS Transcript http://www.pbs.org/thinktank/transcript1292.html
USC Commencement Speech https://gist.github.com/johnz133/7bf10e77d8b994bae743
TED talk: https://www.ted.com/talks/elon_musk_the_mind_behind_tesla_spacex_solarcity/transcript?language=en
Other talks: http://shitelonsays.com/transcript
Cantrell on Quora: https://www.quora.com/How-did-Elon-Musk-learn-enough-about-rockets-to-run-SpaceX
Biography by Vance: http://www.amazon.com/Elon-Musk-SpaceX-Fantastic-Future/dp/0062301233
Wikipedia: https://en.wikipedia.org/wiki/Elon_Musk
Biography.com http://www.biography.com/people/elon-musk-20837159