My views on the market, tech, and everything else

A Dozen Things I’ve Learned from Eugene Kleiner about Investing and Business

Eugene Kleiner was an Austrian-born American engineer and venture capitalist. He worked for William Shockley at Shockley Semiconductor Laboratory starting in 1956. The next year he and seven colleagues (the so-called the “traitorous eight“) famously left Shockley to found Fairchild Semiconductor. They left because did not like Shockley’s management practices or his plans to use germanium to make semiconductors. “Using just $3,500 of their own money to get started, these eight entrepreneurs eventually developed a way to manufacture multiple transistors on a single silicon wafer.” Kleiner was one of the original founders of Kleiner Perkins, which was an early investor in more than 300 information technology and biotech firms, including Amazon, AOL, Brio, Electronic Arts, Flextronics, Genentech, Google, Intuit, Lotus, LSI Logic, Macromedia, Netscape, Quantum, Segway, Sun and Tandem. Kleiner’s obituary in the Economist includes this sentence: “To the end of his life, he called himself an engineer.” Despite his technical background Kleiner made major contributions to the world as a financier. That obituary notes it was Kleiner’s letter “to his father’s stockbroker in New York that was passed to Arthur Rock that set off a chain of events that resulted in Rock moving to California and persuading  Sherman Fairchild, the inventor of the aerial camera, to make Mr. Kleiner’s little group a subsidiary of his company.”


  1. “Invest in people, not just products.” The KPCB web site elaborates on Kleiner’s first point: “Eugene always respected founding entrepreneurs. He wanted to build companies with them not just with their ideas.” The three legs of the stool that drive venture capital returns are: (1) great people, (2) attractive markets and (3) significant innovation.  If you neglect even one of the three you have a big problem. But there are disagreements among venture capitalists about emphasis and phasing. For example, people like Don Valentine argue that you can always replace the people, so it is better to place more emphasis on attractive market. Venture capitalists like Kleiner believe that replacing people is not only hard and unpleasant, but significantly lowers the convexity of the investment. Great people and teams are able to adapt in ways that solve problems. Without great people already in place, preferably missionaries, the probability of survival is significantly reduced in Kleiner’s view. Elad Gil had an interesting post this week on the importance of great founders which included these two paragraphs:

“There are a handful of venture firms that are always thesis-driven, for example Union Square investing in network driven businesses. However, most venture firms are admittedly reactive – they do not have a specific theme they are driving themselves, but rather respond to where the best entrepreneurs are creating the most high growth, high margin, companies fastest.

When lots of VC firms shift into a thesis driven mode, it is usually a sign that organic entrepreneurial activity is no longer sufficient to drive that firms investments. As a result, lots of capital gets invested in areas that do not merit the investment, there is a flurry of activity that looks important (Cleantech), but ultimately this activity does not yield great returns. Typically these areas are ones where the investors lack real expertise.”


  1. “It’s easier to get a piece of an existing market than to create a new one.”  “Two companies fighting over a niche market are like two bald men fighting over a comb.” Kleiner is agreeing with Valentine that attractive markets make the venture capital business model work since there is a need for tape measure financial home runs. The difference is that Kleiner, like Pitch Johnson and many other venture capitalists, consider people to be relatively more important. Kleiner is also saying that it is hard to create a new attractive market where none existed before. He is not saying that creating a new market is not valuable (that payoff can be enormous actually), but instead that it is hard to do. In contrast, fighting with other businesses over a niche market is not likely to be a pleasant or profitable activity.


  1. “Risk up front, out early.” A famous venture capitalist said to me about this comment that Kleiner: “Always had a strong bias of eliminating the biggest risks quickly, which was much more relevant in the days of backing companies with high technical risk and low market risk.” Another famous VC who knew Kleiner well wrote to me that what he meant by this sentence was: “Reduce the biggest risks first for the fewest dollars. This may mean out of order execution to minimize loss in case of failure.” Steve Blank points out that there are different types of risk that must be retired for a business to be a success: “Markets with Invention Risk are those where it’s questionable whether the technology can ever be made to work – but if it does customers will beat a path to the company’s door. Markets with Customer/Market Risk are those where the unknown is whether customers will adopt the product.”


  1. “The problem with most companies is they don’t know what business they’re in.” Venture capitalists who talk about this problem usually see the flip side which is that it can create opportunity for a challenger. This idea being important in venture capital can be traced at least all the way back to Georges Doriot, who said that US Steel did not know what business it was in.  Other venture capitalists believe businesses like Kodak and DEC late in their life had the same problem as US Steel. In the case of Kodak the company invented the technology that would eventually prove to be its undoing. This point made by Kleiner is applicable to service businesses too. For example, Mark Cuban said once: “You always have to know what business you are in. Everybody thought we were in the basketball business. It’s an NBA-team; we are not in the basketball business. We are in the business of creating experiences and memories.”


  1. “Make sure the dog wants to eat the dog food. No matter how ground-breaking a new technology, how large a potential market, make certain customers actually want it.” “There are two types of early adopters. Those who buy and those who want the product given to them.” This quote is a nod by Kleiner to the importance of determining whether there is “product market fit” before scaling a business. Premature scaling is a common cause of startup death. The other point Kleiner is making is that someone must pay for something for a business model to work.  Freemium only make sense as a business model if there is a complementary good that customers are willing to pay for. Rihanna may have a hard time selling music these days since digital music is non rival, but if she uses the fame generated by her music to sell tickets to concerts and t-shirts with her name on them she can still do very well. Her Diamonds World Tour in 2013 grossed US$137,982,530 from 87 shows.


  1. “The more difficult the decision, the less it matters what you choose.” Sometimes you are better off making a decision and living with it than agonizing over the decision for a long period and as a result experiencing a significant delay. Kleiner is saying the harder the decision is to make, the more this is true. One famous decisions concerned what material to use in making semiconductors.  William Shockley wanted to use germanium.  Kleiner ans his colleagues wanted to use silicon instead.  People sometimes joke that without Kleiner the term used today would be “Germanium Valley” not Silicon  Valley.


  1. “Build one business at a time. Most business plans are overly ambitious. Concentrate on being successful in one endeavor first.”  “What tips me off that a business will be successful is that they have a narrow focus of what they want to do, and they plan a sufficient amount of effort and money to do it. Focus is essential.” The number of people who can run multiple businesses at one time is truly tiny. What Steve Jobs did at Pixar and Apple is not normal.  In addition, the propensity of a founder to pivot is negatively correlated with success. Focus matters. When Bill Gates and Warren Buffett met for the first time at dinner that night “Bill Gates Sr posed the question to the table: What factor did people feel was the most important in getting to where they’d gotten in life? And [Warren Buffett] said, ‘Focus.’ And Bill said the same thing.”


  1. “You have to create deals to be really successful.” Success in venture capital is in no small part about hustle. The best venture investors beat the bush for prospects and ideas and have the best referral networks. They are curious and open to new ideas. Reading and talking to people they believe are smart and knowledgeable is a constant activity. Finding the university researchers does not happen by accident. Networks of friends and people you have helped can feed back valuable information in very positive ways.


  1. “The time to take the tarts is when they’re being passed.  When the money is available, take it.” “When the hors d’oeuvres are passing, take two.” Venture capital is a cyclical business. Sometimes it is easy to raise money, sometimes it I merely hard and sometimes it is impossible. It is better to have more money than you need and not need it, than need it and not have it. The absence of cash is fatal. So it is wise to have a margin of safety when it comes to cash. Yes, dilution is an issue but if a venture backed business is a hit, there will be more than enough financial return for everyone.


  1. “Even turkeys can fly in a high wind. In times of strong economies, even bad companies can look good.” This is a variation of Warren Buffett’s point that: “you only find out who is swimming naked when the tide goes out.” The problem, of course, is that you do not always know when a tailwind is about to rapidly slow or even cease. In fact, sometimes you don’t know if what you are experiencing is a tailwind at all. The best founders are prepared for any outcome.


  1.  “It’s difficult to see the picture when you’re inside the frame.” Having perspective on something when you are an insider is hard. Self interest and other biases are powerful enough that dysfunction can result from insider status. The venture capitalist having a network of people who the founders can count on for perspective and feedback is important. Charlie Munger has a great story about this set of issues:

“You also have to allow for the self-serving bias of everybody else, because most people are not going to remove it all that successfully, the human condition being what it is. If you don’t allow for self-serving bias in your conduct, again you’re a fool. I watched the brilliant Harvard Law School trained general counsel of Salomon lose his career, and what he did was when the CEO became aware that some underling had done something wrong, the general counsel said, “Gee, we don’t have any legal duty to report this but I think it’s what we should do it’s our moral duty.” Of course, the general counsel was totally correct but of course it didn’t work; it was a very unpleasant thing for the CEO to do and he put it off and put it off and of course everything eroded into a major scandal and down went the CEO and the general counsel with him. The correct answer in situations like that was given by Ben Franklin, he said, “If you want to persuade, appeal to interest not to reason.” The self-serving bias is so extreme. If the general counsel had said, “Look this is going to erupt, it’s something that will destroy you, take away your money, take away your status…it’s a perfect disaster,” it would have worked!”


  1. “Venture capitalists will stop at nothing to copy success.” The venture capital industry has no shortage of camp followers and poseurs like other industries. It is a fact of life that in capitalism that any success will be quickly copied and that moats are needed to sustain any profit. The best venture capitalists are already leaving a market, when the poseurs show up. What is the moat in venture capital itself? My view is that it is cumulative advantage that causes a few firms to have persistently  higher returns. The best essay on this topic  was written by Duncan Watts and is entitled: Is Justin Timberlake a Product of Cumulative Advantage?   http://www.nytimes.com/2007/04/15/magazine/15wwlnidealab.t.html?_r=0



Giants: http://web1.poly.edu/alumni/_docs/Giants-Kleiner.pdf

Economist Obituary:   http://www.economist.com/node/2265786

NYT Obituary: http://www.nytimes.com/2003/11/26/business/eugene-kleiner-early-promoter-of-silicon-valley-is-dead-at-80.html

KPCB: http://www.kpcb.com/design/on-investing-by-eugene-kleiner

Elad Gil:  http://blog.eladgil.com/2016/07/end-of-cycle.html?utm_campaign=digest&utm_medium=email&utm_source=app&m=1

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