460. Unraveling Start-Up Success with Mike Maples, Jr. and Peter Ziebelman

Yes indeed. Or was the book named after the podcast? No, I think we renamed the podcast to match the book.

And even the goal, Greg, we're not trying to get a recipe. In fact, one of our internal mottos was 'the recipe is there is no recipe.' So we're not going back and looking at successes and failures to try to pattern match and share that with the world. What we're trying to do is understand truly what happened in the ideation phase. And that's where Mike's... you were there, he saw so much of this. And the stories are not only good in the book, but they're revealing in terms of what did these breakthrough founders do that was different than other founders who had a great team, had great backing, but didn't make an extraordinary success like those few founders.

Yeah, I think that's right. But I think that what we learned as we worked on this some more was that you could offer an explanation. So if you think about what makes a valuable corporation, I think most people would agree that it's an organization that has a set of advantages and barriers that it creates that enable it to persistently compound value over time. So if you said, 'When I'm investing in a Fortune 500 company, what am I really betting on?' I'm betting on the ability of it to persistently compound its advantages for longer and more intensely than the rest of the world believes. Well, it turns out a startup doesn't have any of those things. They don't have a moat, they don't have any advantages, they don't have customers, they have no five forces or Hamilton Helmer's seven powers. They have none of those things. So then what is the right explanation to tease out startup success? And that's kind of where the thought processes of the book came in. So what we think with inflection theory is that you have these inflections that occur that provide massive new types of empowerment. It could be a new GPS chip in a smartphone, it could be a new microprocessor enabling the PC, it could be a new large language model enabling AI. But the high-order bit is that those inflections allow startups to fight an unfair fight. Rather than the incumbents having the advantage of incumbency and protecting their moat and their advantage, the startup is now able to refuse the premise of the rules of competition and impose a new set of rules by bending the arc of the present to a different future. So that's what founders do when they're succeeding: they harness inflections and they have some type of an insight that harnesses that, and then from that they create these products that change the rules and change how people think, feel, and act. And when they do that, they play offense and they change the future. So the thing that was powerful about some of the ideas was it did offer an explanation. It wasn't just 'we studied a bunch of things and found this set of patterns.' It was like, there's a mechanism for how it happens. The inflections initiate the mechanism for changing the future and changing the rules and letting the startup play offense. And what we discovered is that there's the potential in there. It doesn't mean that it's going to be a breakthrough. We truly came out of this... Mike, wouldn't you agree that it'd be amazing if you could say 'oh that's a breakthrough, that's not a breakthrough' and do your investing that way? So there's still a lot of luck and perhaps intuition, as you said Greg, and guesswork to determine whether you're going to fund a breakthrough or build a breakthrough. But having said that, we do believe there's these elements that can tip the balance. And Mike already mentioned one: inflections. Another element is seeing that the entrepreneur has an insight, something they know to be true that others do not yet believe. And we believe insights are one of the things that does explain a lot about startups, even before you get to the MVP and other ways that traditionally teachers like myself have described startups.

Well, I would say that fundamentally we follow the founders. It's the founders that are leading. At best we're riding shotgun, and our job is to be co-conspirators to them in the early days and to provide whatever help we can in them fulfilling their mission. But usually it's the founder that shines the light for us towards a different future that we end up believing in, that they found. But what I would say is that we apply the theory in our own investing, but in a slightly different way. We don't apply it for coming up with ideas, but when we look at ideas, there's so many ideas and there's so much noise. You have to have a basis, you have to have a framework to evaluate them. And so the inflections allow us to discard ideas that sound good on the surface but that aren't that powerful, but it also allows us to protect ideas that sound crazy at first but might be the right kind of crazy.

Yeah, so I think you want to be persistent about your insight and open-minded about your implementation of the product. The insight is sort of like the red thread of the startup. If the insight is something that the founding team knows about the future that's radically different than the present and that has the virtue of being true, and if what you know about the future isn't radically different, you won't have a breakthrough. If what you know about the future isn't true, you won't have a breakthrough either, because you don't have an insight, you just have a wrong opinion about the future. So the insight is the reason to keep going, the one unique asset that you have. The implementation of your insight—a couple of things can cause you to need to make changes. You might be talking to the wrong audience, so you might have the right insight but you may be talking to the wrong people. If you have a cloud computing idea and you're only talking to SAP customers on-prem, your insight might be right, you're just talking to the wrong people. But you might also have the wrong implementation. In the case of Okta, they were talking to cloud early adopter customers, but they were showing them problem resolution at first and they said 'no, that's not what we want, we want identity management.' So they came back with identity management. So if you have the right insight, when we talk about pivoting, your insight is like your pivot foot in basketball. You hold it planted firm and you move your body by either modifying your implementation or modifying the audience that you talk to, or some combination. But if you have to leave your pivot foot, you're no longer attached to anything as a startup. You might as well start over, you might as well try a new idea or just give up. So that's where I think you reconcile it. You want to be flexible in your experimentation of navigating your insight to the destination, but you want to be fixed about what you believe is different about the future.

Have you seen that? No, for sure. And I think I don't think I could do that. I think there are certain investors that also have that in their head, that they can be so excited about a certain area but then know that area is done and need to move on. And those are two qualities that are hard to live in the same person, and it's a very rare quality. So I love what's behind your question there.

You know, I think there is an aspect of it that's innate to people. Way back when, probably about a hundred years ago, Pareto wrote about society and he talked about speculators and rentiers. And the way I internalized that was he thought that most people in the world were like rentiers, examples of people who want to succeed through persistent compounding, through saving what they already have, making the most of what they have, and not losing what they have. And that's quite often the instinct of most people. And the speculators—he didn't mean it in a gambling sense, this is before Las Vegas or any of that stuff happened—entrepreneurs, right? The speculators speculate that things can be different, and they always believe that whenever they hear a story, there's always a possible better story that exists somewhere. So those are just two different ways of showing up in the world. Some people are like 'hey, I want to keep what I've earned and I don't want to screw this up and I don't want to lose what good I have,' and there's other people who are just like 'there's probably always a better answer somewhere, there's probably always a better way to do it.' So I do think that people are probably naturally wired to be one way or the other, and I think probably the minority of people are wired to be speculators naturally. I think most people want to fit in and be well-liked within the social dominance hierarchy.

Yeah, and they're so good at it that they actually look at surprises as something to actively seek. And I've learned this from founders. I try to journal each day now, and one of the things I ask every day is 'what surprised you today?' just as a life practice. And I'm not an entrepreneur, I'm not Jack Dorsey or Evan Williams or Brian Chesky or any of these guys. But what we've seen is a lot of people think success means finding out why something's not working and filling the gaps. But a lot of times success is noticing something that's working better than you thought it should work, and realizing that you just earned a secret about the future, even if it was somewhat serendipitously. And so a lot of the examples that we have, and we call it savoring surprises, but when you think about lean startups and running experiments, one way to think of an experiment is 'I have a hypothesis, I run an experiment, I want to validate my hypothesis.' But there's only one problem with that: if all you do is validate your hypothesis, you didn't really learn anything, you just underscored what you think you already know. And what you'd really like to do in an experiment is get more confidence in the things you should be confident about, but conduct the experiment in a way that you're going to get surprised somehow on the upside.

Yeah, so I think what we're getting at is that if you look at tech startups, which is definitely a particular field, the top startup of the year is usually more valuable than all other startups of the year combined, and the top startup of the decade is usually more valuable than all the startups of the decade combined. So the power law is real. And so if you're going to start a startup, the problem is that if you're average, you fail. If you're even better than average, you fail. If you're in the top 20%, you do only okay. And so what makes the sacrifice and the time worth it is to go after ideas that have breakthrough upside potential. And so what a lot of founders do, and this might resonate with some people listening right now, is they say 'oh, for me to get one of those big outcomes, I need to start with a big market and work backwards to an unserved customer and solve their unserved needs.' But by doing that, the entrepreneur unwittingly buys into a context which is 'I'm going to compete according to the rules already established by the incumbents.' Because if you're trying to find white space in the available market, it's an existing market defined by somebody else. And so what we're saying is, instead of starting with an available market, start with inflections. Start with a new set of powers that allows you to not compete within current markets but to change the subject and create new markets. And the way you create new markets is you have a product that defines the market. And the way you have a product that defines the market is you show up with a radically different value proposition that nobody's ever seen before, that can't be compared with anything that's come before. And in order to do that, it just requires, like Peter said, a completely different mindset. There's no recipe or set of steps you can follow. There's a belief system that you adopt, which is to pursue things that exist in the future that follow inflections, that harness an insight, and that can change the subject rather than be better than what's out there. And we're surely saying that's still hard to do. It doesn't happen often, it's very difficult to do, and when you do take a swing at it, you're likely to fail. You're not going to come up with that insight, the inflection you found is going to be ephemeral or something that is really not changing the world the way you thought it was going to. But having said that, once you do figure this out, we could actually argue—I don't think Mike, we'd say it in the book, so tell me if we're overstepping here—that once you found it, it's actually less risky, in terms of expected value but just risk, less risky overall than following a recipe that 40 of your classmates can follow, coming out with the same company, and you each think you can build a $10 million, $100 million company and sell it for $50 or $300 million, but you've got 40 classmates doing the same thing and you're going to compete yourself into a race to the bottom. And so it could be argued that that actually is the riskier approach. Now Mike, do you think I'm getting into trouble on that?

No, I don't think so. I think another way I've internalized it is that a lot of people confuse risk and uncertainty. So I might have an idea that's in an existing market that there's a clear need for, but it's a bounded upside idea. But I can connect the dots between the idea and customers wanting it and a successful business. I might on the other hand have an idea that's like Justin.tv, which is a reality 24/7 streaming TV show, which is crazy online, but it embodied a lot of inflections and an insight. It was a terrible idea but a great opportunity. And so what we're interested in is not certainty about the future, because if we're going after a non-consensus idea, if we have a real insight, we can't know we're certain yet. All we can know is that we're non-consensus. But just because we don't know how the dots will forward connect doesn't mean they won't forward connect, and it doesn't mean that the expected value of the upside isn't higher. And so that's what we encourage people to say: just because you don't know how the success will happen doesn't mean that it's not way better odds to pursue that path.

Yeah, you know, I think that first of all, selecting the right founder and opportunity contributes to the majority of success if you're an investor. That's like an understatement. And then luck may be the second biggest factor. So then you start to say, 'okay, as an investor, how do you add value if you ever do?' And I think it's in more limited cases than people often realize. So I like to say that 95% of the time, the founder should understand what to do better than I should, or I made the wrong investment, I bet on the wrong founder. There are certain times though where you just have some perspectives. For example, I have a database of every startup I've ever been able to find where you would have made more than 100 times your money on the first check. And so I thought about what are the most successful startups ever that did premium, or that did enterprise, or that did subscriptions, or you know, what were the most successful startups that saved money for customers, what were the most successful that made it more fun for customers, or that gave them social status, or whatever. And so sometimes, because I've thought about all of those companies in great depth, I can offer the founder something they haven't thought of before, because this startup is their only startup, this is a one-time thing for them. Or sometimes I'll know what the issue is, we'll agree on what the issue is, and I will know the best person when it comes to that topic. But it's... I think a lot of it is knowing when you can help, and knowing that if you don't know you can help, usually you're doing the opposite, you're just adding to the noise and the confusion that they experience.

Well, we kind of get into that. Mike?

Well, it's... I think that what happens ironically is that it's the good companies that fall into the trap, because the good companies are excellent at executing their strategy, and they hire people who are very talented and able, and they advance in the organization because they execute the strategy really well. And it's like you mentioned bias earlier. The bias comes from a bias to executing according to that model, that set of patterns. And so ironically, the better you are at executing your business and the more attractive it is, the more you're likely to be stuck in current patterns, and the more rightfully so you're likely to believe in the current patterns. And so it becomes very difficult to come up with a pattern-breaking, totally radically different strategy. And I think that there are ways around it. I think that Vinod Khosla has an interesting view on this, and I may not be quoting him exactly, but one way to think about it is a company should allocate a certain amount of profits to initiatives that are likely to fail but have massive upside if they succeed. And you just decide what that threshold is. Is it 5% of profits? Is it 10% of profits? Whatever it is. But it's the very act of trying to do something radically new and allowing failure to be okay, and holding the overall organization accountable for success because you take enough bets. But to say, 'look, we're just going to have a philosophy of making, you know, not too big to fail, but small bets that if they work are wildly asymmetric upside.' Make that part of our culture. I think that's really important, because otherwise you become committed to the existing pattern. And the pathological thing that happens is like Blockbuster is a great example of this. What happens if the pattern means most of your profits come from late fees? Well, pretty soon you start to try to encourage your customer to return products. You start to act in ways that are against the interests of the customer and against the interest of compounding value in a real way. And you start to become more concerned about the institutional imperative than in creating abundance and value for people. And we've seen a similar issue when larger companies acquire our companies. Everybody gets excited about the exit, but we tend to know the routine. The CEO will stay on, will have a contract to stay on for three years, but will stay only one or two. And all of a sudden the product is absorbed, and the creativity and the passion and the zeal that they had before is diminished. Even though the parent company is wanting to retain all that, acquisitions I think are particularly problematic as well.

Well, I don't know. I guess the other observation is that the established company starts out with a different set of assets and liabilities. So yes, they can have a bias, but they also have assets that they can combine with inflections. So if you look at the iPhone, it's a really good example where they used OS X, they used their iTunes software, they used their video playback software. So they had a good suite of software that they combined with this sort of touch interface and the new microelectronics and sensors. But a startup wouldn't have been able to do the iPhone because a startup just wouldn't have had the portfolio of assets. And so I think that the way that the large company plays offense is they say 'I want to use inflections to change the subject, but I need to form a connection between those inflections and something about my franchise that's already there.' And I think that that's the real opportunity. If that's not what they're doing, then I think usually M&A, you know, it's more like Facebook buying Oculus. Facebook's like 'we don't know the first thing about virtual reality, let's just go buy a company that's good at that and start over in that space.'