You’re not Michael Jordan…nor Steve Jobs

I will never forget the moment in my athletic career where it became painfully obvious that I was not going to be as good as Michael Jordan.  I was at the Sixers basketball camp in up-state Pennsylvania and the team’s shooting instructor was giving a talk.  He started by explaining a dunk he witnessed live where Jordan got so high, his leg literally wrapped around another player’s shoulder.  A 6 foot 5 inch player.  His punch line, you will never, ever be able to do that…so if you want to play in high school (or maybe college), work on your jump shot, not your acrobatic lay-ups.  Ugh…that hit me like a ton of bricks.  It was at that point that I realized he was probably right.  I became immediately self-aware that I was a short, slight-built Jewish kid from the suburbs who had trouble touching the net.  [I also realized my jump shot was not good, but that is besides the point.]

Last week a friend forwarded me the New Yorker article on Steve Jobs.  I have read many articles on Jobs.  The one consistent theme that stands out to me  in all of the articles is how he was able to be so successful while being such an ass hole.  Now, I am not kicking another man’s gravestone.  I am sure Steve had been called much worse when he was alive.  I am sure he knew that people didn’t like him.  But every time I read something about his management style, I am left wondering how he was able to attract and retain such talented people.  And build such great products and companies with that tyrannical style.  I guess he was just so damn talented.  But while his success is to be admired, his management style is not something to be copied.

There are a few examples of ass hole leaders that are still able to build great companies.  By all accounts, Bill Gates fits this description.  Jeff Bezos seems to be a real jerk too.  One disclaimer, that I have never met any of these leaders, nor worked in their companies, so I am just going by the numerous, and consistent, accounts that I have read.  But these guys are extremely rare.  And do not demonstrate leadership styles that an entrepreneur should pattern themselves off of.

In my opinion, great leaders are great listeners.  They set a great vision and then empower teams by creating a sense of ownership throughout, rather than subservience to the all-powerful ruler.  My experience is that a team of talented people always beats one great mind.  And the best way to build a great team of talented people is to foster open, candid communication where the best idea wins, regardless of who came up with it.  I certainly have a strong opinion on subject matters.  And I will always challenge the subject matter experts on my team when I disagree with them.  But I try to always leave those debates with them feeling empowered rather than beaten into implementing my wish.  I want my team members to feel a sense of ownership over their domain.  I try very hard to never make them feel like they are simply implementing my will, even though my voice is clear throughout the product.  I am not perfect.  I make mistakes.  And sometimes it is what it is. Sometimes you just have a disagreement and someone has to make a call and that someone is the CEO.  But in general, I try to stay away from my team leaders and let them run their unit.

I find this is a good style because it scales.  It scales for several reasons.  A few are:

  1. Truly talented people thrive in that environment.  Your “B” players fail quickly, and then it becomes obvious that you need to make a move.
  2. It builds trust, accountability and ownership that permeates the organization.
  3. It stretches people to find out how good they are, and thus pushes them to work harder or stretch further.

I learned this style from one of the best.  I was lucky enough to work for several great leaders in my short career.  But one in particular stands out as a world-class operator.  His greatest skill is that he is an amazing people manager.  Elite talents like to work with/for him because of how empowering he is.  And so, no matter what business he starts, he always has an amazing Rolodex of talented people who want to be a part of whatever he thinks is important.  He manages those relationships carefully.  He is extremely responsive in emails, always replying the same day.  He is available for phone calls.  He always listens and always has good recommendations.  He is supportive and empowering.  You always know his vision and his parameters, but you feel empowered to take ownership within those requirements.  That is a skill that is attainable for any entrepreneur/business leader.  Bill Gate’s brilliance is not.  Nor is Steve Job’s design sense.  Those skills are comparable to Jordan’s vertical leap.  But this leader’s empowering style is attainable from any manager willing to work hard at it….just like a good jump shot.

9/14/11 = The Day facebook MySpaced itself

One of the things I find most interesting about competitive strategy is that the patterns play themselves out over and over again.  Regardless of industry.  Regardless of who has made the same mistake before them.  There are tried and true strategies of how a dominant incumbent losses its position.  And if you know these patterns, you can see them before they happen.  And they almost always play out exactly as expected unless the incumbent recognizes it before it is too late or the switching costs become too high.

As I said in my “Explaining Twitter” post, social platforms reflect a continuum of tight to loose networks of people.  Each major platform has formed an ecosystem.  Twitter is an ecosystem of extreme loose networks.  LinkedIn is between tight and loose networks.  Facebook was designed to build tight networks (first starting with your college friends).  They each have gained popularity because I have different desires from each network, and these platforms solve those needs.

One of the key strategic mistakes that plays itself out over and over is when a dominant player, with a defined ecosystem, feels competitive pressure from its flank and defends itself by adopting features of that competitor.  The result is a dilution of its value proposition to its users.  Put in sports terms, it is now playing its opponents game rather than sticking to its game plan.

On September 14, 2011 facebook announced the subscription feature.  This feature is a mistake.  I sincerely hope facebook recognizes this soon and rips it out.  Here is why this feature is a mistake:

1.  It dilutes the tight network ecosystem I have come to expect from my of my facebook stream.

Trying this feature out, I have subscribed to interesting people, i.e. people who are leaders in industry, but not friends.  (Stop me if you see where this is going.)  My newsfeed is now dominated by posts (mostly news articles) by interesting people, whom are not my friends.  Sound like any cool service you know?

2.  Subscribers scare me.

I still remember when I got my first subscriber.  Some random dude I have never met in Eastern Europe.  I have no idea how he found me or why he subscribed to my FB stream.  But I didn’t like it.  Of course, he only sees my feeds that I make public.  But that filter is so hidden that it won’t be used, let alone understood.  So I am left with the feeling that I have stalkers watching my updates that are only meant for my friends, whom I have permissioned in.  On the flip side, Twitter is understood to be public, so my tweets are much less personal than my wall posts.  Said differently, that European dude has no business in my facebook.  If is creepy. And makes me more leery of sharing what I like to share with my friends.  His place is to follow me on Twitter, which are known to be public.

The Upshot

Sean Parker has famously said, the only reason facebook won is because MySpace screwed up.  And the only way facebook loses is if it screws up.  He is at Twitter now, so maybe he is happy to see this screw up.  But I am not.  I love facebook and want it to continue to win.  I am building my second social business that leverages facebook heavily.  So it is my sincere hope that facebook doesn’t get diluted and start to lose its subscribers.  But I see facebook executing the same pattern it used to beat MySpace…i.e. diluting the core of its user experience.  Zuck-dog, if you read this, please step in and rip out Subscriptions.

Choices, not Decisions

An entrepreneur recently told me, “we try to give our customers choices rather than forcing them into decisions early on in the process.”  I can’t think of a more perfect way to frame the design of User Experience.

In this context, the word Choice is used a little differently than the common definition. Choices are low friction options in the user flow (not necessarily multiple options as the common definition suggests).  Choices are activities that seem like no brainers and carry little (or no) cost to the consumer.  By contrast, a Decision is a user activity that causes you to pause and say “hmmm, Is the benefit of that step really worth the cost?”  The obvious example is a forced log-in.  On our team, we call decisions “Gates.”

Our team’s rules with gates are:

  1. Never gate unless you have to.
  2. If you think you have to gate, see if there is a way to not gate and still provide the appropriate user experience
  3. Never gate early in the process
  4. Always show the user what is on the other side of the gate…and that better be damn compelling.
  5. Always offer an escape hatch for the User.

When building a product, it is very easy to get sucked into designing a flow to match the corporate goals rather than optimize for the user’s experience.   The classic example: We want to grow, so let’s put a page early on that asks you to invite your friends.  Invite my friends?  Are you kidding?  I just signed in, I don’t even know what your site does?  You want me to invite my entire facebook friend list?  Fuck you…I am out of here.

Our VP of Product said it better, “treat your customer’s time preciously.”  Boom!

It is harder than it sounds.  The dark side of corporate goals are always pulling you to think selfishly.  But a good product is one that is optimizing for the consumer, yet finds ways to achieve its corporate goals within that framework.

Why it is Hard to Please Normals

A friend and adviser recently shared with me a great way he looks at consumer products.  He classifies his potential audience into two buckets – Early Adopters and Normals.  The Early Adopters label he borrows from Crossing the Chasm (which I highly recommend to anyone who hasn’t read it).  So I wanted to focus on the Normals group.

What is a Normal?

Simply defined, Normals are people who do not know (or care) what an API is.

Another test…if you find software interesting, then you are not a Normal.

How do you please Normals?

Normals just want cool/interesting/thought-provoking products that are simple and give payback in under 5 seconds with little/no work on their part.  To break through the daily clutter, a product has to also have a wow factor, while providing the utility.  All with no work to achieve this wow.

An example of a product feature that meets these criteria is the side swipe arrow to unlock an iPhone.  If you have an iPhone, you know what I mean.  It just feels cool every time you do it.  Blackberry has a similar code you have to type in to unlock the phone.  Blackberry just doesn’t have the side swipe feature to get to the code.  Blackberry is a utility.  iPhone is a great consumer product.  I think you know the rest of the Blackberry vs. iPhone story.

What is so hard about that?

Building great consumer products for Normals is very hard.  It is hard for many reasons, below are two:

1. The makers are typically not Normals, so they have to constantly divorce themselves from their daily routine.

  • When making a product, you have to get into the weeds.  Making good software is hard.  Things break if you don’t do them right.  I have sold late version software for very large companies, so I can say definitively that technology breaking is not only a start-up issue.  Different pieces have different limits.  Only by getting into the weeds can a product manager understand the limits when building the UX.  So the PM has to get into the weeds, but can’t stay there, however enticing it is.
  • When making a product, you spend every waking (and most dreaming) minute thinking about your product.  The result of this obsession is that you understand your product in a way no one else does.  Features that seem so obvious to you, often are not obvious to others.  Discovery isn’t as intuitive to others as it is to you.  This is a really, really big risk.

2. Normals don’t give good feedback while the product is being built.

  • Want an exercise in futility, show wire frames to a Normal.  Focus groups for unfinished products do not work in my opinion.  Normals need to see and play with finished products to understand it enough to give feedback.

How do you solve this problem?

  1. Build a lean, agile development process
  2. Get product out fast
  3. Set up a process to garner real-time feedback
  4. Iterate
  5. Repeat

This is the core component of the Lean Start-up approach, which is all the rage in VC circles now.  They used to call this process bootstrapping in my day (i.e. I graduated college in 1998).  Whatever you call it, staying small, keeping costs down, getting product out fast, actively seeking feedback and iterating is the best way to please Normals, i.e. people different than you Mr. Founder.

Explaining Twitter

I am amazed at how many people who I know tell me that they don’t understand Twitter. Let me re-phrase that…I am amazed at how many people who I know that use facebook religiously and don’t understand Twitter.  Here is the short explanation of Twitter…Twitter is similar to the facebook newsfeed for people whom you are interested in but don’t know. If you want the long answer, then read below.

(note, if you don’t know what the facebook newsfeed feature is, you should stop reading this now…you won’t get it. You should also get your head out of your ass and recognize that it is 2011 and nearly 1 billion people use facebook. You should at least understand it.)

Social Media as I understand it.

In real world life, you have networks of people who are somehow connected to you. These networks span a continuum of how closely connected you are to the network participants. Some networks are made of tight affiliations – i.e. your family and closest friends. People you would tell anything to. You also have networks of acquaintances, i.e. people you have done business with, or friends of friends. And you have extremely loose tie networks, i.e. people whom you have never met, but follow in a voyeuristic manner (i.e. Kim Kardashian). These people entertain you or are people you aspire to meet/know/be. Social media platforms reflect your personal network continuum. Each has a unique ecosystem that fit neatly into these three buckets:

  1. Tight-tie networks
  2. Acquaintance networks
  3. Loose-tie networks

Social media platforms exist to simplify communication and/or provide entertainment/distraction while appealing to our natural desire for information or voyeurism from these three network groups.

  • facebook was initially conceived to discover what was going on with your college friends. The natural growth for a medium like facebook is always to move toward the tighter end of the continuum. Meaning, if you sign up because all the cool kids on your college campus are using facebook, you will recruit your besties and probably your family. facebook’s power is that it not only captures a communication (and voyeuristic) medium for your tight network, but also your close acquaintances. It is also no secret that facebook’s initial use case was to help you get laid in college. Which is a very powerful use case.
  • Moving to the right on the continuum is LinkedIn. That network is almost entirely made of acquaintances…specifically business acquaintances. LinkedIn’s ecosystem has evolved where you can “connect” with people you have a business meeting with. It is like saying, “hey, I want to check out your resume before our meeting.” It is a low threat way to give information about your professional history/skills.
  • Moving to the extreme right of the relationship continuum is Twitter. Twitter is almost exclusively built to improve communication among people whom you don’t know, and probably will never meet.

Twitter’s Product

For those of you whom have never used Twitter, think of it as the newsfeed feature of facebook, which anyone who wants, can view by “following” you. Not only can people see your newsfeed (which is contained to 140 characters on Twitter), but you can see anyone’s newsfeed, just by “following” them. You can search for people and click a follow button and you are plugged into their Twitter stream. If you read something interesting that someone you follow wrote, you can “re-tweet” it and anyone who follows you, can see it in their feed.

How I use Twitter

I use Twitter for two purposes:

  1. More relevant newspaper. I follow interesting people, who often Tweet interesting news that they create or read elsewhere. I basically let them filter the news for me. And I digest what’s left with a smile. It is really interesting info.  Anyone can and should use Twitter for this use case even if they never Tweet or get a follower.
  2. Spread interesting info I create or find elsewhere to my Tweeps (i.e. Twitter followers).

Twitter’s Power

Twitter’s power is rooted in its loose tie network. The reason this network has been built so fast is due to the fundamentals of its product.

  1. Low threat connecting – Following a newsfeed is a low threat action. So low threat that stars are willing to let you follow them.
  2. Low friction content creation – 140 characters is easy to type
  3. Big, non-overlapping circles. I think of the world as a series of concentric circles of people. The looser the affiliation, the less overlap in the concentric circles. The less overlap, the more people hear about news that is passed on from people who you know (or whom follow you). This power is leveraged by the re-tweet feature.

Given the above product design, information flows faster and wider on Twitter than on any other medium in the world. Let me emphasize that point…a company started in 2006 moves information faster and to a wider distribution than any other medium in the world. All due to the power of social media and the loose tie design of the product. Pretty neat…huh?

Badges do NOT equal Gamification

Dennis Crowley (founder of Foursquare) is largely (and accurately) credited with a new wave of innovation that promotes adding unique features to a consumer application to make it seem more like a game while also providing its value.  Foursquare’s success with these features has created a big buzz word in the start-up community…Gamify.  Talk to investors and you hear it all of the time…how are you gamifying?  What is your gaming strategy?  So, like all “hot” ideas, people rush to copy it without understanding it properly, and thus do not implement it properly.

I am not a hard-core gamer, but it seems to me that to make something a game, you need a challenge and a reward.  Games are often more fun when the challenges are competitive with only one winner.  Foursquare has nailed this with their mayorship feature.  But many copycat consumer apps really miss this point.  Giving people badges for doing things on your site is NOT the same as adding a gaming element to your user experience.  To make your UX a game, people have to knowingly strive to successfully achieve the challenge.  Frankly, I am sick of getting stupid badges for doing nothing.  “Hey, you just signed up…you got a Rookie badge.”  Really?  Where is the game in that?  That’s just plain stupid.  I now hate your site and will never return.

Bottom line, adding a gaming element to a user experience is a great idea.  If it is artfully done, it can help create explosive growth.  But forcing it into your UX for the sake of checking a box for investors is dumb.  And is likely to have the opposite effect of what was intended.

Stay Hungry. Stay Foolish.

In honor of Steve Jobs’ resignation from Apple, I wanted to post one of his famous speeches.  His commencement speech from Stanford.  I don’t think that it is possible to capture my core beliefs better than how he does.  I have never met him before.  And I actually never read this speech until this morning.  However, and quite coincidentally, I try every day to practice what he preaches.

I talk to friends all of the time about career stuff.  My advice is always the same.  I always ask, what are they truly passionate about?  And then I say, “just do that.”  Most of the time, they respond with reasons why they can’t.  And I always respond the same way….just do it.  I truly believe that life rewards those who follow their passion.

I hope you enjoy Steve’s speech as much as I did:

“Find What You Love,” Steve Jobs’ at Stanford University

I am honored to be with you today at your commencement from one of the finest universities in the world. I never graduated from college. Truth be told, this is the closest I’ve ever gotten to a college graduation. Today I want to tell you three stories from my life. That’s it. No big deal. Just three stories.

The first story is about connecting the dots.

I dropped out of Reed College after the first 6 months, but then stayed around as a drop-in for another 18 months or so before I really quit. So why did I drop out?

It started before I was born. My biological mother was a young, unwed college graduate student, and she decided to put me up for adoption. She felt very strongly that I should be adopted by college graduates, so everything was all set for me to be adopted at birth by a lawyer and his wife. Except that when I popped out they decided at the last minute that they really wanted a girl. So my parents, who were on a waiting list, got a call in the middle of the night asking: “We have an unexpected baby boy; do you want him?” They said: “Of course.” My biological mother later found out that my mother had never graduated from college and that my father had never graduated from high school. She refused to sign the final adoption papers. She only relented a few months later when my parents promised that I would someday go to college.

And 17 years later I did go to college. But I naively chose a college that was almost as expensive as Stanford, and all of my working-class parents’ savings were being spent on my college tuition. After six months, I couldn’t see the value in it. I had no idea what I wanted to do with my life and no idea how college was going to help me figure it out. And here I was spending all of the money my parents had saved their entire life. So I decided to drop out and trust that it would all work out OK. It was pretty scary at the time, but looking back it was one of the best decisions I ever made. The minute I dropped out I could stop taking the required classes that didn’t interest me, and begin dropping in on the ones that looked interesting.

It wasn’t all romantic. I didn’t have a dorm room, so I slept on the floor in friends’ rooms, I returned coke bottles for the 5¢ deposits to buy food with, and I would walk the 7 miles across town every Sunday night to get one good meal a week at the Hare Krishna temple. I loved it. And much of what I stumbled into by following my curiosity and intuition turned out to be priceless later on. Let me give you one example:

Reed College at that time offered perhaps the best calligraphy instruction in the country. Throughout the campus every poster, every label on every drawer, was beautifully hand calligraphed. Because I had dropped out and didn’t have to take the normal classes, I decided to take a calligraphy class to learn how to do this. I learned about serif and san serif typefaces, about varying the amount of space between different letter combinations, about what makes great typography great. It was beautiful, historical, artistically subtle in a way that science can’t capture, and I found it fascinating.

None of this had even a hope of any practical application in my life. But ten years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography. If I had never dropped in on that single course in college, the Mac would have never had multiple typefaces or proportionally spaced fonts. And since Windows just copied the Mac, it’s likely that no personal computer would have them. If I had never dropped out, I would have never dropped in on this calligraphy class, and personal computers might not have the wonderful typography that they do. Of course it was impossible to connect the dots looking forward when I was in college. But it was very, very clear looking backwards ten years later.

Again, you can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future. You have to trust in something — your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.

My second story is about love and loss.

I was lucky — I found what I loved to do early in life. Woz and I started Apple in my parents garage when I was 20. We worked hard, and in 10 years Apple had grown from just the two of us in a garage into a $2 billion company with over 4000 employees. We had just released our finest creation — the Macintosh — a year earlier, and I had just turned 30. And then I got fired. How can you get fired from a company you started? Well, as Apple grew we hired someone who I thought was very talented to run the company with me, and for the first year or so things went well. But then our visions of the future began to diverge and eventually we had a falling out. When we did, our Board of Directors sided with him. So at 30 I was out. And very publicly out. What had been the focus of my entire adult life was gone, and it was devastating.

I really didn’t know what to do for a few months. I felt that I had let the previous generation of entrepreneurs down – that I had dropped the baton as it was being passed to me. I met with David Packard and Bob Noyce and tried to apologize for screwing up so badly. I was a very public failure, and I even thought about running away from the valley. But something slowly began to dawn on me — I still loved what I did. The turn of events at Apple had not changed that one bit. I had been rejected, but I was still in love. And so I decided to start over.

I didn’t see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me. The heaviness of being successful was replaced by the lightness of being a beginner again, less sure about everything. It freed me to enter one of the most creative periods of my life.

During the next five years, I started a company named NeXT, another company named Pixar, and fell in love with an amazing woman who would become my wife. Pixar went on to create the worlds first computer animated feature film, Toy Story, and is now the most successful animation studio in the world. In a remarkable turn of events, Apple bought NeXT, I returned to Apple, and the technology we developed at NeXT is at the heart of Apple’s current renaissance. And Laurene and I have a wonderful family together.

I’m pretty sure none of this would have happened if I hadn’t been fired from Apple. It was awful tasting medicine, but I guess the patient needed it. Sometimes life hits you in the head with a brick. Don’t lose faith. I’m convinced that the only thing that kept me going was that I loved what I did. You’ve got to find what you love. And that is as true for your work as it is for your lovers. Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven’t found it yet, keep looking. Don’t settle. As with all matters of the heart, you’ll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don’t settle.

My third story is about death.

When I was 17, I read a quote that went something like: “If you live each day as if it was your last, someday you’ll most certainly be right.” It made an impression on me, and since then, for the past 33 years, I have looked in the mirror every morning and asked myself: “If today were the last day of my life, would I want to do what I am about to do today?” And whenever the answer has been “No” for too many days in a row, I know I need to change something.

Remembering that I’ll be dead soon is the most important tool I’ve ever encountered to help me make the big choices in life. Because almost everything — all external expectations, all pride, all fear of embarrassment or failure – these things just fall away in the face of death, leaving only what is truly important. Remembering that you are going to die is the best way I know to avoid the trap of thinking you have something to lose. You are already naked. There is no reason not to follow your heart.

About a year ago I was diagnosed with cancer. I had a scan at 7:30 in the morning, and it clearly showed a tumor on my pancreas. I didn’t even know what a pancreas was. The doctors told me this was almost certainly a type of cancer that is incurable, and that I should expect to live no longer than three to six months. My doctor advised me to go home and get my affairs in order, which is doctor’s code for prepare to die. It means to try to tell your kids everything you thought you’d have the next 10 years to tell them in just a few months. It means to make sure everything is buttoned up so that it will be as easy as possible for your family. It means to say your goodbyes.

I lived with that diagnosis all day. Later that evening I had a biopsy, where they stuck an endoscope down my throat, through my stomach and into my intestines, put a needle into my pancreas and got a few cells from the tumor. I was sedated, but my wife, who was there, told me that when they viewed the cells under a microscope the doctors started crying because it turned out to be a very rare form of pancreatic cancer that is curable with surgery. I had the surgery and I’m fine now.

This was the closest I’ve been to facing death, and I hope it’s the closest I get for a few more decades. Having lived through it, I can now say this to you with a bit more certainty than when death was a useful but purely intellectual concept:

No one wants to die. Even people who want to go to heaven don’t want to die to get there. And yet death is the destination we all share. No one has ever escaped it. And that is as it should be, because Death is very likely the single best invention of Life. It is Life’s change agent. It clears out the old to make way for the new. Right now the new is you, but someday not too long from now, you will gradually become the old and be cleared away. Sorry to be so dramatic, but it is quite true.

Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma — which is living with the results of other people’s thinking. Don’t let the noise of others’ opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.

When I was young, there was an amazing publication called The Whole Earth Catalog, which was one of the bibles of my generation. It was created by a fellow named Stewart Brand not far from here in Menlo Park, and he brought it to life with his poetic touch. This was in the late 1960’s, before personal computers and desktop publishing, so it was all made with typewriters, scissors, and polaroid cameras. It was sort of like Google in paperback form, 35 years before Google came along: it was idealistic, and overflowing with neat tools and great notions.

Stewart and his team put out several issues of The Whole Earth Catalog, and then when it had run its course, they put out a final issue. It was the mid-1970s, and I was your age. On the back cover of their final issue was a photograph of an early morning country road, the kind you might find yourself hitchhiking on if you were so adventurous. Beneath it were the words: “Stay Hungry. Stay Foolish.” It was their farewell message as they signed off. Stay Hungry. Stay Foolish. And I have always wished that for myself. And now, as you graduate to begin anew, I wish that for you.

Stay Hungry. Stay Foolish.

Thank you all very much.

Explaining Groupon’s Losses…Organizational Optimization

So much has been made recently about Groupon and LivingSocial’s large financial losses.  Yesterday, a friend forwarded an article that claimed, “Groupon’s fundamental problem is that it has not yet discovered a viable business model.”  Imagine that, the company that Forbes dubbed the fastest growing company in the history of commerce doesn’t have a business model.  They went from $0 to $3+ billion in annual revenues in 3 years.  Yet still do not have a viable business model?

The reason that the financial blogs/sites and academics love to rail on Groupon is the huge loses that they are generating creating those revenues.  But with everything….you have to peel back the layers to understand it properly.

There is no debate that spending $4 billion to generate $3 billion is not sustainable.  The author of the HBR article goes so far as to compare Groupon to Pets.com, the internet bubble poster child.  However, it is important in any analysis to understand the drivers of the short-term losses and the long-term unit profitability.  I guess those small points slipped his mind.

For example, after looking at the large loses on Groupon’s P&L, what if you then come to understand this point buried in its filing:

the company spent $18 million to add about 3.7 million subscribers in the second quarter last year. By the first quarter of this year, those individuals generated $145.3 million in revenue and $61.7 million in gross profit.

hmm…that seems like a good return to me.  And a viable model.  Of course, in the second quarter of last year, it looked ugly.  That being said…someone smart enough to be a Fellow at the Harvard Business School’s Forum for Growth and Innovation can’t get past the current-year losses.  Either he (along with the Groupon bears) is missing something or the Groupon bulls (myself included) are missing something.  He states his argument in the HBR article, here is mine…

  • High growth companies (and start-ups) can only optimize one thing at a time.

Boom…there it is.  That’s the answer.  Good night…tip your waitress….

…Not convinced?  Continue reading below:

Right now, Groupon (and LivingSocial) are focused on optimizing to gain subscribers at a price below an estimated CLV (customer lifetime value).  Of course they can not know the real CLV because they are such new companies.  But they do have some benchmarks to estimate (as noted above).  Because this is their focus, these companies have built their organization around this focus.  They are pumping huge sums of money into marketing to gain a dominate and defensible position in new markets.  They are doing this because in their business, there is limited supply of quality product in a given market.  Meaning in the daily deals business, there are a limited number of quality deals in any market.  Far lower than the 365 days in a calendar year.  Revenue follows the 80/20 rule.  So you need to get those high quality retailers.  And the high quality retailers will work with the vendor who has the most scale and brand cache.  Thus winning the scale war in the market, becomes a self-fulfilling prophesy.  Therefore, both companies are in an all out blitz to “win” a market.  If you have ever worked for an uber-growth company, you know what this is like on the inside.  It is a full speed, all hands on deck, maniacal focus on growth.  If there is a conflicting decision to be made – growth wins.  If you are not sure if something will work, you try it.  If it fails, so what?  Move on.  Go…Win..Do it and ask permission later.

Then comes maturity:

When markets mature, companies shift from optimizing for growth to optimizing for profitability.  As the daily deals market matures, you will see Groupon (and LivingSocial) change their focus and thus their organizational optimization design too.  They will do basic stuff like:

1. Launch new products to get a higher share of wallet from existing customers.  Note both companies recently started doing this.

2. Scale back marketing in maturing markets, which I am sure they have already started doing (but do not have any inside information on so I have no idea if LS or Groupon are doing this yet).

3. Optimizing internal operations for profits, rather than growth.  I.e. you revisit those decisions where growth won over profitability and process.

4. Change pricing.  See Netflix

5. Offer premium services to niche customers.  See LinkedIn.

A firsthand example…

I know this process because I have seen this a few times from the inside.  One relevant example was maturation of DoubleClick.  I joined DoubleClick in 2000, when the company was growing 100% per year.  By 2001, it was clear the business was changing dramatically.  Our client base was dwindling with the .com bust.  So in 2001, David, the President of DoubleClick, started the Business Operations team in the Technology division.  He asked Neal to run the division and asked me to join as well.  We then hired this guy and Neal also brought on Nicole.  The four of us focused entirely on profitability.  And within a few weeks, it was obvious that there was so much low hanging fruit.  There were so many easy things that could be done to improved the profitability of the business.  We used the same maniacal focus to push through operational changes, and the results were that DoubleClick maintained profitability throughout the entire .com bubble burst…largely on the backs of the Tech Division.

When I first joined the group, I remember being amazed that no one had done these “obvious” things before our group did them.  But after more reflection, the answer was obvious…because no one was focused on those things.  Prior to the crash, DoubleClick was growing 100% per year.  It was an all hands on deck situation just to maintain the growth rates.  Growth was the only way to beat competitors.  And since Ad Serving was a winner take all market, we needed growth to win.  The organization was optimized to growth and that metric always won internal debates.

But when that changed, so did the focus.  And thus the organizational optimization.  Keep in mind, high-growth companies already have people who enjoyed a maniacal focus on one thing.  We just shifted the definition of winning.

Important lesson for entrepreneurs:

I wrote about this topic for two reasons:

1. I am a significant shareholder in LivingSocial and believe its model is getting a bad rap from people who don’t understand it.  LivingSocial’s acquisition of my company has been credited by the LivingSocial management team as the pivot point that got them into the daily deals business.  I was a General Manager and VP of Sales of LivingSocial when we started the Daily Deals biz.  So I understand the economics of the business.  Once they make the shift, I think they will start generating great operating margins.  I think it will ultimately look like a search business.  Every incremental conversion will cost nothing.  In the mean time, they are doing the right thing by investing heavily ahead of demand to gain a dominate position in new markets.  But I am a bull on LivingSocial, so feel free to discount the Daily Deals specific points in this post.

2. Unrelated to my ownership in LivingSocial, I think there is an important lesson for entrepreneurs….Focus your limited resources on one big thing.  Optimize your entire organization for that ONE thing.  Do it better than anyone in the world.  Tell your investors what you are doing and what the ride is likely to look like.  If they are good investors, they will support you while you are in-pursuit of those milestones so long as they understand what achieving these goals will lead to.  If they are professional investors, they will support you even if it looks ugly along the way.  Ignore the outsiders.  Focus on executing.  Hit milestones.  There is time to optimize on other key metrics later.

Join-ins are better than Earn-outs

I had breakfast with a fellow entrepreneur and friend recently who is in the middle of a particularly sticky acquisition negotiation.  He is the acquiring company and is having difficulty reaching agreement on valuation for the business he is buying.  In M&A land, when this happens, the most common tool used is called an Earn-out.

Detour – definition of an Earn-out: For those of you who don’t know what an Earn-out is, it is basically kicking the can down the road.  It is an agreement that says we will value your business at a specific multiple of your future performance.  For example, if your revenues are $1 million in 2012, you will get valued at 2x or $2 million.  If they are $1.5 million, then you will get valued at $3 million, etc.  These deals are often done to bridge a deal divide caused by different opinions on a future event, in the previous example, future revenues.  The challenge in an earn-out scenario (i.e. after the deal is closed) is often that the acquiring entity has a lot of control over resources which can make it hard (or easy) for the seller to achieve the earn-out.  And while it would seem ridiculous that a company would acquire another company and not do everything in its power to make that acquisition immediately successful, that is exactly what happens.  I have been on both sides (acquiring and selling) of an earn-out and I can guarantee you this is how it works.  Personally, I hate earn-outs both as a buyer or seller.

End-detour, back to my friend’s story: What is interesting about my friend’s deal is that both sides seem to agree on what revenue and margins the business can do in 2012 independently.  The challenge is that they can’t seem to agree on the value the combined business, which will begin raising money about six months after the deal closes.  The acquirer (my friend) has a strong sense of valuation based on market comps.  But the seller doesn’t.  Adding to the challenge, the two businesses overlap so much, that keeping separate books is impossible, making an earn-out also impossible.  This complexity has led my friend to walk away from the negotiations three times.

We went back and forth during breakfast for a while, before I suggested an idea that might lead to a deal break-through…rather than an earn-out, do a Join-in.  This term, which I made up at breakfast, means base his valuation on the valuation the combined company gets in the market.  The higher the valuation, the bigger the equity stake.  And since the key driver of the company’s valuation is going to be total revenues, tie the seller’s ownership stake to the combined company revenues.  Give the seller every incentive to exceed the revenue goals of the combined entity.  This structure aligns incentives in a way that earn-outs do not.  What is also good about this structure is that it clarifies the sand-bagging that always happens when exchanging financials.  When I finished explaining this structure, it seemed like a light bulb went on for my friend.  Hopefully it leads to a deal.  Good luck friend.

The first 1,000 user problem, i.e. why consortium apps don‘t work

Almost every day you hear about a new hot app.  Gets lots of buzz, raises some money and is featured on TechCrunch.   Most of these apps are built around a consortium model.  Meaning, they are great if everyone is doing it.  But they suck when they first launch.  The shining example of this is the Color app.

The Color Case Study of failure:

Color launched to a lot of buzz and hype a while back…i.e. in March.  It passed the “three ass test” that VCs like to apply to investments – i.e. kick ass team, cool ass product, big ass market.  It was founded by 3 star entrepreneurs all with amazing credentials.  They had a vision to disrupt Facebook (hmmm…where have I heard that before).  And their technology was cool.  They even coined a new market, the virtual network (i.e. the people who are near you whom you don’t know nor care to meet).  This puppy was hot, hot, hot.  They used the three checks on the “ass test” to raise $41 million from well-known and respected investors.  Pause for a second and realize they raised $41 million before they launched their product.  Without knowing the valuation, I would have to guess their post money value was at least $100 million. [I couldn’t imagine 3 top entrepreneurs selling more than 50% of their company on a series A round.]  So they got a valuation greater than $100 million before they had any customers.

After they raised their monster round, they launched their product and…thud.

The problem..

that Color’s app has is that they had a product that would be really cool ONLY if everyone used it religiously.  But they had a terrible experience for new users.  Do I really need to type all of the reasons that is a fatally flawed assumption?  Within a few days after launch, the rock star CEO admitted this problem.  No offense, but that is a really big whiff guys.  [Off point, but an interesting post script is that 2 of the 3 rock star founders have already left the company.  That’s right, 2 of the 3 stars left after a few months.]

Bottom line…

you can’t get to 5 million users if the first thousand users have a terrible experience.  Entrepreneurs should spend more time focusing on use cases that are fun/engaging/problem solving for the first thousand users, rather then dreaming about how cool the product is going to be once everyone in the world is a user.