Episode 106- Square Founder Jim McKelvey on How We’re Thinking About Innovation All Wrong

So I use an archaic definition of the word 'entrepreneur' because in order to write my book, I needed one. It was really funny because when I started to write the book, I needed a word to describe a certain type of business person who wasn't copying what everybody else was doing, and it turns out we have no word in English for that now. We used to. It turns out that interestingly enough, a hundred years ago, the 'entrepreneur' label meant somebody who was in business but they were not doing normal stuff; they were experimenting with things that hadn't worked or might never work, like things like airplanes. You know, before the airplanes were ubiquitous, we had people who were trying to fly and most of them died. A lot of them have funny videos where they collapse and fall off cliffs and burst into flames. If you were doing that sort of stuff a hundred years ago, we'd call you an entrepreneur. Now if you're running a coffee shop a hundred years ago, we would have called you a 'business person.' These days, the word entrepreneur is interchangeable with business person, so if you start a business you're an entrepreneur. I couldn't use that definition because to me, I need to draw a line between the two worlds because behaviors are different and the results are vastly different depending on which world you're in.

Well, the perfect problem that Square started with was how do small merchants accept the dominant form of payments, which are credit cards and debit cards? How does a little merchant accept a piece of plastic? Back in 2009, you couldn't do it, and you would lose sales. I was losing sales. I was a small merchant. I sold stuff, and if they couldn't pay with a credit card, I'd lose the sale. I lost a sale and I got upset. Jack Dorsey and I were friends, and actually he used to work for me at another tech company that I still have. He had been recently released from Twitter and was looking for something to do, and he called me and asked me if I wanted to start a new company with him. In the middle of Jack and me brainstorming, we ran across this problem where as a small merchant, I lost a sale.

So maybe I'll start by defining the term 'perfect problem' because I use it very specifically. A perfect problem to me is one that is solvable but has not yet been solved. Take all the problems in the world that can't be solved yet, and those are stuff we should ignore. Take all the stuff that we've solved, and those are kind of boring. Then you're left with this sort of middle ground of stuff that hasn't been done but could be. We believed that allowing small merchants to take credit cards was something that could be done but hadn't been done yet, so that was our perfect problem. It's interesting because if you begin to solve a problem that has never been solved before, you're not guaranteed that you will succeed. There's no formula; you don't get to just copy what's been done by other people. That's really scary. When Jack and I started, literally on the first day, before lunch, I discovered at least two or three laws that we would be breaking with every transaction. I discovered some of the reasons why other people had not done this before us. We had this funny lunch where we're like, 'Well, do we quit now?' Jack was like, 'No, we keep going.' I was like, 'Great, let's keep going.' And Tristan was like, 'Hey, as long as you guys pay me.' So that was the magic moment where we realized what we were doing was harder than we thought.

Well, we're familiar with each other. Fear came to Thanksgiving with us this year; it's ever-present in my life. I've heard many times people, sometimes very successful people, preaching boldness and saying you should be fearless and willing to risk it. They give examples of people throughout history who've faced tremendous hardship. But it's funny if you talk to these people. I have an uncle who fought in World War II; he's 98 years old and won a Bronze Star. He doesn't like to talk about it, but occasionally when the moon is right, he will tell you what it's like to have been a literal war hero in the greatest war there was. He was afraid. He had to take out a German machine gun nest by himself, and he did it. I won't share his story right now, but he was terrified. But he functioned anyway. That to me is more familiar. In other words, I do things even though I am afraid, and I have learned that I can still function even though I'm afraid. If I get into trouble, I'm terrified, my hands sweat, I have all the classic reactions to fear, but I don't freeze up. And that's probably good.

Yeah, if you've gotten away with things in the past, you recognize that there's a pattern here. The biggest thing that I've learned is that you don't want to freeze up; you don't want fear to become paralytic. One of the things that I benefited from: I learned how to fly airplanes. Flying airplanes is not hard at all; it's actually pretty easy to fly an airplane. It is, however, important that you fly the plane because when things go wrong, as does happen, you will have to make decisions, and you can't not make those decisions. You can't just sit there gripping the yoke paralyzed because you will die. So one of the things that they train pilots is to fly the plane, do the thing that you've been trained to do, or at least do something, but don't just sit there and take it. That helps a little bit. The reason I talk about this is because my book is an answer to all these terrible platitudes that I've been fed all my life: 'Be bold,' 'Be creative,' all this crap that I get handed by so-called experts. It never worked for me, and I thought, 'Well, wait a second, maybe there are other people who have been needing the same.' So I hate business books; I genuinely detest the things. And I wrote one now, but if you read the average business book, it's this self-serving diatribe of somebody who is either successful and didn't acknowledge how terrified or lucky they were, or somebody who wasn't successful and is just good at writing books. I was dead set against writing a book, but I got a homework assignment from Herb Kelleher, one of my idols. He gave me a day of his time; we sat down and talked about the research that I've been doing. At the end, he said, 'Jim, you can't just sit on this as some personal anecdote; this has to be something you share with the world.' So I wrote a cartoon—my first four drafts of this book were a graphic novel. The only reason the final book is not a graphic novel is because when I told Herb that I'd written a graphic novel, he got really upset. He said, 'That's trivializing an important thing. You can just leave me out if that's how you want to do it.' And I was like, 'I can't leave Herb Kelleher out of the story.' So I rewrote it as a book. But this was the thing that I wished I'd had when I was younger.

Well, in fact, it was a normal inclination for us as well. We had one consultant at the very early days who was a top-level executive at Mastercard. He agreed to come in and give us his wisdom for thousands of dollars. We looked at what he was advising, and everything he was advising was basically cloning the existing industry. We weren't building for the existing industry. He was trying to get us to copy what everybody else had done for this market that we weren't trying to serve. He was trying to get us to build a system to serve big merchants, not stuff that was appropriate for these small merchants who had been excluded. So all his advice was classically bad. What we finally realized was, 'Wait a second, why are we paying somebody all this money to tell us to do basically the opposite of what we're going to do?' So we got rid of him. At that point, we were like, 'Well, why would we ever want to pollute our thinking with expertise?' I'm not saying that this is good behavior; I'm saying that this is good behavior if you're an entrepreneur. If you're doing something that's never been done before, then there are no experts.

When I had to write this book, I had a person in mind. I have to do something for somebody else. I had a very specific person in mind: she's brilliant, she's got a master's degree from one of the world's best educational institutions, super hardworking, bright, personable—all the qualities that you would associate with success. But this is the funny thing: I've seen her when she gets to the edge of her competence. When she encounters a problem where she can't study or copy the solution, she freezes and says, 'I'm not qualified to go any further. I can't do this because I'm not qualified.' My response to her, which is now a 300-page book, is: 'Okay, I understand. In some cases, if you're not qualified, you should stop and go find somebody who's qualified, or go get qualified yourself. But what if what you're trying to do has never been done? What if you're the Wright Brothers?' I'm a qualified pilot; I can go fly a plane because I got trained. I'm going to take a medical exam next month; I have to pass a certain standard, otherwise the FAA will ground me. But the Wright Brothers were absolutely not qualified to fly that plane. No human on the planet was qualified. You can't be qualified to do something the first time in human history. I wrote the book because all of us, at some point in our life, are going to run up against the line of what humanity has done. We'll look over that line and say, 'I wish I had this thing that hasn't been invented yet.' Every one of us is going to feel that fear that comes from leaving the world where we're qualified to do something and stepping into the world where we're unqualified.

Energy, energy, energy. If you're doing something entrepreneurial, you have a real problem because most people will come into your business, look at what you're doing, and say, 'You're crazy. Why the heck would I do something that doesn't have a known outcome when I could take a job here with a better guarantee?' So you very quickly realize that if you're honest with your employees and coworkers, most of your prospects will quit; they won't work for you in the first place. You're left with a sort of weirdo bunch to begin with—folks who are willing to do something that hasn't been done, that doesn't have that guarantee. So it's a special group. What you're looking for, at least for me, is just energy, raw energy. All of Square's design was done by a 19-year-old. We set the standard for design with a 19-year-old. The guy who was running our most successful line of business now came in as an assistant to a supposedly qualified guy who we had to fire. We're looking for that energy, pure enthusiasm and energy, because that's what's going to sustain you. Expertise is irrelevant. We might as well just go for energy.

I believe disruption is retrograde. I believe disruption is looking back and moving backwards, a lot of times because you're looking at something you want to destroy. Look, I get it; we all want to destroy some stuff. I can't believe there's not a lot of potential political disruptors out there going, 'We got to find a better way than this.' My problem with disruption is that it focuses your attention on the thing you want to blow up. Because of that, you spend a lot of time looking at a model that is not relevant for the future. If you're going to build something that's totally new, don't hire experts from the past and don't put your attention on things that are out of date.

Yes, you are. There's an innovation business: consultants, seminars you can go to, spend a week glamping and come back with a fleece jacket that says 'I'm an innovator.' People make money peddling innovation. But when it's packaged, I believe it's the wrong sort of stuff. I believe innovation, if we're honest about it, is a last resort, and it should be thought of as a last resort. In other words, if you've got a problem, first try to copy the solution from somebody else. Find somebody else who's solved it and, for God's sake, do what they did. Don't try to be innovative and do something new; that's usually a recipe for failure. But when you run up to that line where humanity has not figured out how to do what you want to do, that's the point where you have to innovate. It's not a choice. Innovation is one of those things you almost have to force yourself to do because it is so unnatural. Because these seminars and this marketing machine tries to peddle innovation as something we should buy and ingest like vitamins, we end up doing the wrong thing, and all it does is turn our urine funny colors.

Yes, because look, I'm not somebody who sits there and criticizes the system. I'm on the Federal Reserve, for God's sake. I am the system now. I have to vote on an interest rate on Thursday. I don't want to live in a lawless country without a central bank; I love having a central bank; it's actually really good. Don't just scream 'destroy, destroy, destroy,' but understand when a system is failing and when it needs to be reinvented or discarded for something new. It begins from a position of respect. The respect that I show is to look at solutions and brilliant strategies that have come before me, that have been thought of and refined by millions of brilliant people, people way smarter than I am. Why would I not try to learn from them first? But then understand that at some point, occasionally, I run into things that have not been solved. At that moment, I have to sit there and make a choice: do I choose to take this other path called innovation? And what does that path look like? It's the difference between being a tourist and an explorer. I travel a lot, and most of the times when I travel, I'm a tourist. I'm not an explorer. I take a trip in a couple of days and expect the city to have drinkable water and food; I expect a certain level of stuff. I'm not sitting here thinking I may have to kill my own dinner.

The worst thing that could possibly happen to a startup happened to us. About three and a half years in, Amazon decided that they wanted to take our market. They did what Amazon does: they copied our product and undercut our price by 30%. They always pick 30% to undercut the price by. When Amazon does that and adds all their brand and other power to promote what they're doing, they win. That always happens. At least in 2014, when it happened to us, we looked for counter examples of companies who had beaten Amazon and found nobody. No survivors. Poor Tony Hsieh just died last week; I miss Tony so much. We went out and visited Zappos. We asked Tony, 'You got attacked by Amazon.' He said, 'Well, we still got bought by Amazon; we ended up part of the beast.' Tony, badass entrepreneur, greatest customer service guy, couldn't beat him. I talked to the guys at Diapers.com; they got swallowed. Everybody got wiped out by Amazon. So here is Square, this little company, still small, and Amazon's coming at us with their 100% effective formula. We had to respond. We looked at all the things we could do and couldn't think of anything that would be an effective response. We couldn't find any companies to copy, so we just kept doing what we were doing. We basically ignored the whole thing, including matching their price. The easiest thing to do took some nerve. Our price was not arbitrary; we were charging a price that was fair but allowed us to continue in business. The price that Amazon was charging would have been impossible for us to maintain. It was a non-decision. We didn't understand how they got that price. What were they doing to allow them to do that? How brilliant must these people be? It turns out they couldn't. We actually ended up hiring some of the people from Amazon afterwards, so I know a little bit more of the backstory now. Amazon was just copying Square. I go through the math in the book, and this is the reason I wrote the book: we beat Amazon. Then I had this survivor's guilt. It's like when you live and you don't think you deserve to. Everybody around you is dead, and you're still standing. You go, 'Wow, what's so special?' I had this entrepreneurial survivor's guilt. I went looking for examples of other companies that had had the same thing happen to them and found that throughout history, there were a bunch of startups who've beaten companies who totally should have wiped the floor with them. They all had this thing called an Innovation Stack. They all had this pattern that they fell into. I was like, 'Oh my God, what I found here is a regular, repeatable pattern.' The problem was I only did historical research, so all of my subjects were long dead. I couldn't just call up the people I was studying because they were... but Herb Kelleher, the legendary founder of Southwest Airlines, was still alive. I called up Herb, and he was so generous. He met with me down in Dallas, and I spent a day with him, basically showing him my research. I said, 'Herb, this is what I think happened to Southwest Airlines, and I think Southwest, even though it's a totally different industry, fits the same pattern of what happened to Square, what happened to Bank of Italy, and all these other companies. Herb, you lived through it. I'm just going to shut up and listen.' Herb got really excited. He said, 'Jim, it happened this way to us. I never thought of it this way, but yes, there's a pattern. How are you going to tell the world this?' I said, 'I guess I got to write something.' One of my heroes gave me homework.

I do. I have what I think is an answer. This wasn't a scientifically controlled experiment, but I've seen the pattern dozens and dozens of times, if not hundreds of times. Here's the pattern: when you do true innovation, which begins by not copying, you are forced to create not one invention, not two inventions, but probably 20 or 30 or 50 different things. That's what invention and innovation looks like. It's this messy iterative process, and it builds this thing that I call an Innovation Stack, which is just a bunch of different things that you do for different reasons. I outlined in the book that Square did about 14 things that were radically different from every other credit card processor in the world at the time. I outlined Southwest Airlines that did 20 things differently. I talked about this little company called the Bank of Italy, which by the way became the biggest bank in the world, and they did about 15 things differently. I go through these examples again and again, showing how first of all these Innovation Stacks are built, and secondly, how it is for a competitor to try to copy one of these things. It turns out it's really hard to copy an Innovation Stack from the outside. These things are incredibly protective, so much so that it protected our little startup against Amazon. It protected Southwest Airlines against all the major air carriers and the federal government. It protected this little bank in California against all the banks in New York and the government. It's this amazing suit of armor.

Well, it's a way of solving a problem. You pick a problem that has never been solved before and you try something. It may work, it may not work, it's probably not going to work, and then you try something else. Maybe that thing works partially, but it causes other problems. To give a concrete example, Square wanted to have a simple price. You should know what your credit card charge is going to be. Seems simple. Turns out nobody in the industry was giving a flat price; they were all giving these really complicated prices. The reason I believe they were giving really complicated prices is because complexity hides crime. You can have something so complicated that even Walmart doesn't understand what a credit card costs. I have from the head of Walmart's payments, a guy named Mike Cook. Mike told me, 'Jim, we don't know exactly what we're going to pay until the next day.' The rules are so bizarre. This is the guy who does more credit card processing than anyone else in the United States and probably in the world. If there is an expert, it's Mike Cook, and Mike threw up his hands and goes, 'Hell, I don't know.' If Mike doesn't know, you sure as hell don't know. Why don't you know? Because they're taking your money in 100 different little tricky ways. We didn't want to do that; we wanted to be transparent. So we came up with a simple price. Surprise, surprise, that simple price didn't work because we had to connect to all these banks, processors, and credit card networks that had these complicated pricing rules. All we did was we threw our balance sheet in front of our customer and the ultimate credit card system; we were taking all the punches. That meant we lost money on certain transactions. If you bought something for less than $4 on Square, we lost money. We're eating all these charges. How do we survive this? The answer was we have to grow. We have to have so much business that it offsets this loss. We had to grow really fast. We needed people to be able to sign up easily, so we had an online service agreement, which at the time was against all the rules. You couldn't not have 42 pages of physical paper and wet ink signatures and faxes and all this other crap. We said that's nonsense; this is 2010; we have computers, people have the internet. So we built this little online contract. That caused all sorts of other problems, so we had to do something else and something else. At the end, we ended up having to build 14 things differently in order to have this system work. When it finally worked, it was this miracle because nobody else had it, nobody else could copy it, and we basically had this giant market to ourselves.

Sense of humor helps a lot. If you'll notice in the book, it's just a bunch of jokes strung together. I feel like I stuck a dirty joke in that book that was so bad. I don't know if you liked it; you have to be pretty bad. I grew up with twin brothers that were older than me, worked with athletes; I've seen it. There's some stuff in there that even my editor was like, 'You can't put that in.' But having a sense of humor helps. Being able to laugh at yourself helps. Having a good team of energetic people helps. But at the end of the day, you got to recognize where you are. You're in this world where there is no guarantee, and you must at some level accept that it's an acknowledgement. There's no checklist. I took this book around a bunch of publishers. One of the big, big, big business publishers, one of the more respected publishers in New York, looked at it and said, 'We won't publish your book unless you put a checklist in it.' I was like, 'Look, my book is talking about the unknown. How the hell am I supposed to put a checklist? How many items should I put on the checklist?' They said, 'Oh well, five to seven.' I was like, 'Dude, this isn't a good fit.' You have to understand if you're going to step across that line between the world of solved problems and into the world of unsolved problems, and you believe that you are capable of creating a new solution for the world, there's no guarantee it's going to work. There's no formula to follow. The best you can do, Molly, is to acknowledge where you are. It's even worse if you think you're in the world of guarantees and certainty and you hire the experts and think you can buy your way out of a problem. No, you don't get that guarantee; you have to live without the guarantee. The only thing I say to my readers and to the people is, 'Look, I'm not going to give you a formula for it. What I'll give you is a touch of familiarity, so that when you find yourself in that position, if you choose to be in a situation where innovation is what you have to do, and you feel that discomfort and that fear and all that stuff that still terrifies me, at least you'll recognize it.'

Well, I think so. To me, it is foolhardy to do something that's unnecessary and risky. If you're innovating and inventing something that's already been invented, why would you do that? Then there's this innovation that sort of passes off as incremental stuff, like the blue specks in laundry detergent. I'm sure that was an innovation of something, but they don't do anything. That's the marketing department, not someone with a chemistry degree. I think if you're going to criticize a system, which I do because I'm writing a book on innovation, which is an implicit criticism of things as they are now, you begin the critique with the utmost respect for the thing you're critiquing. You begin the critique by understanding what you're attacking and why it exists. Acknowledge its shortcomings, but do that from a position of respect. I begin my book with the utmost respect for copying your way through life. I know a lot of really happy people who have never done an original thing in their life, and they are super cool, very successful. You can copy your entire life; you do not ever need to do anything original. But I don't want the whole world to be people like that. I want those of us who choose to innovate to have a little bit more weaponry when we do.

How do you keep going? This is the question: what keeps you going? We talked earlier about how I try to hire people who are super energetic even though they're not experts because there can be no experts. I myself have motivational problems. I'm one of these people that I would probably still be in bed if it wasn't for this interview. That's hard for me to believe? Well, my daughter would have jumped on my head at some early hour anyway; perhaps that's not entirely true. But I do have motivational problems. Because I have motivational problems, what I've learned to do is put myself in situations where I have to act; I don't have any choice. This afternoon when I'm flying a plane, I don't have a choice. Well, I could choose to die, which I'm not going to do. Even if I'm a little bored, I'm not going to have motivational problems as soon as I retract the landing gear. No motivational problems whatsoever; I know I got to do this thing. So the question is, if we take motivation and slice it into two areas, there's 'grit,' 'persistence,' 'stick-to-it-ness'—all that positive stuff we've been taught from the early days. 'This person is tenacious,' all that good stuff. What if you're not tenacious? What if you're not that motivated? What if you're somebody who will literally watch everything on Netflix tonight? For those of us with the ink worn off the buttons on our remote control, I offer another solution: be audacious. Put yourself in a situation where you have no choice but to act or die. That's audacity. Do something that hasn't been done. This is one of the great tricks of entrepreneurship: if you pick the right problem and it's audacious enough, you don't really have to be well motivated. You have to not quit, but it's pretty easy to not quit if the alternative is peril. If your business is going to go away, or in my case this afternoon, I will literally die if I give up. I'm not going to give up. I will be here tomorrow because I'm not going to quit when I'm at 5,000 feet. That's just not gonna happen.

That's the secret thing that I found because I studied all these super successful entrepreneurs throughout history. We're told hero stories. Herb Kelleher, total badass. By the way, Molly, I tried to make this mistake: I wrote a graphic novel first, five drafts of my book were graphic novels. You know who was wearing a cape in the graphic novel? Herb. He didn't want to be portrayed the guy. The guy was so brilliant, I miss him so dearly. But he was like, 'Don't use a graphic novel because that's a hero story. Don't make this a cartoon; that's a hero story. We don't separate these normal people who achieved abnormal success from the rest of us.' The people that I studied in the book were profoundly humble people. By 'humble,' I don't mean that sort of false modesty you're taught in school, but that sort of deep self-doubt that comes across as humility. I found that and I was like, 'Oh my God, because I had always been taught that successful people were bold, stronger than me, younger, older, smarter, better, and they had more perseverance.' Whatever the superlative was that they had and I didn't have was the reason I was unsuccessful. That was my sort of thinking. Then I do this research and I meet some of these people, and then I study the rest in history. I was like, 'Oh my God, humility is this thing that they share in common.' It is this deep humility, this respect for the fact that you are scared or you don't know the answer. You don't know the answer because it's never been done before; don't feel bad about that. But there was a tremendous amount of self-doubt and just general hesitation because when you're innovating, that's how it feels. That's how the process is done. Maybe there's somebody out there who's bold. I just haven't met the bold people.

Neither, because I get awakened by a two-year-old. I don't get to be a night owl anymore because I get up involuntarily with my daughter. With a full diaper, she crawls and she's learned to sit on my head.

I am an introvert who has learned to project out of self-preservation. To save my company, I learned how to sell, but I'm not a classical extrovert in any way. I love people, but I'm more shy than outgoing.

Nervous. Just nervous. I sit there and I twitch. I get worried when there's a problem, and I think nobody's going to solve it. I feel like I've got to be the guy to do it. It's a good source of energy, though—nervous energy.

Probably 'annoying.' Being around somebody who constantly drives things forward. I have to leave my own companies. There was no way I was going to stick around Square once the product was out the door. There was no way I could stick around after the core mission was set up. I started a non-profit called LaunchCode, and I had to leave it. I love LaunchCode; I love what we're doing, and I had to go because I have too much nervous energy. I want to do too much. At some point, once you've built the Innovation Stack and the company is running, you need me to get the heck out of the way. Yeah, I annoy a lot of people.

Well, I've been made aware of it. Let's guess where that awareness might have come from.

Favorite book right now: I'm reading Churchill.

My father. He just died last year. He was this beacon of integrity and calmness. I have very few of his qualities; I wish I had more of them. He is a quiet man, deeply humble, super smart. I tried to read his book once, and the math in his textbook stopped me on the second page. I ran up against a second-order non-homogeneous differential equation. I was like, 'Dad, geez, come on, man.' I couldn't read it. I couldn't even read my own father's book. But he inspired me because whenever I was deeply in trouble, I would go home and sit with my dad. We wouldn't talk; we would just sit in the same room because he wasn't a talker. I would say, 'Dad,' and he'd hear all these things and say, 'Okay.' Then I'd say, 'Here's what I'm thinking,' and he'd say, 'Okay.' He never, in 55 years, gave me any advice. This is a guy with a PhD; he was dean of the engineering school. The engineering school is named after him now; it's called the McKelvey School of Engineering. It was just so wonderful to have this kind and brilliant person in my life. He was my rock. I deeply miss him.

I like Elon Musk. I've only met him a couple times; I wouldn't say we're friends or anything. But what I liked about him is if you know his story, he earned his own money and then he bet it on these crazy ideas. How they land the rockets at SpaceX? They didn't think that was going to work. The first eight or ten times, it didn't work; it blew up and blew up again. Here's a guy who sticks his neck out for companies like Tesla and SpaceX and the other stuff that he believes in. I just love that attitude: 'I'm going to make a bunch of money, and because it's my money, nobody can stop me from doing these nutty things.' The nutty things in his case have worked, but what I respect more is this ability to become successful and then not become a hoarder. Go solve another problem. Because once you become successful, at least in the eyes of society, there's a lot of pressure on you to quit. 'Don't do something else that might not work and prove that it was luck. Take your winnings and go to the buffet.' But it's an inspiration to me to see somebody who is doing stuff that might not work at scale and publicly. So I give a tip of the hat there.