When I think about continuous improvement, I think about this small plaque at the EAA AirVenture Museum in OshKosh, WI.
In 1903, the Wright Brothers made the history books with the first "controlled, powered and sustained heavier-than-air human flight." Everyone celebrates the first flight, which was 40 yards in about 12 seconds.
The most interesting aspect of the day is how much the Brothers improved. By the end of the day, they stayed in the air 59 seconds (391% improvement) and traveled 852 feet (610% improvement). In terms of speed, the first flight was 10 ft/second; the final flight of the day was 14 ft/second (40% improvement).
Being in the early-stage space means that you’re constantly talking about ideas. The idea might be a new feature for an existing product. Or, it could be a pie-in-the-sky idea for a yet-to-be-formed company.
Talking ideas is fun. But sometimes you run into an “Idea Hater.” You know, the person that says one (or all) of following things, repeatedly:
Are these folks wrong to ask such questions? Hell no! It is vital to understanding the competitive landscape, technical feasibility and strategy for establishing a moat. But what defines an Idea Hater is someone that regardless of the answers still believes the product or company cannot be created, let alone successful. Idea Haters do not believe another great company can be built.
But all around us, crazy ideas are being turned into great companies. Here are two of my favorites. So the next time you run into a Hater, share these ideas as a reminder that innovation is alive and well.
Airbags for bicyclists
The pitch: “What about using airbag-like technology to create a more comfortable bike helmet. Think about it. It is inflatable airbag that cyclists wear around their necks, like a scarf. It’s light, stylish and unencumbering. In the event of an accident the airbag inflates and protects the rider's head.”
This crazy idea is brought you by Hovding.
A Smart Saw
The pitch: “You know how the iPhone doesn’t work if the person is wearing gloves. It’s like the iPhone knows the difference between flesh and other materials. Well, what about a saw that detects the difference between wood and flesh. And if it detects flesh, it immediately stops the saw and saves the craftsman finger, hand or arm.”
This idea by SawStop actually works. It's the reason my father-in-law still has all ten of his fingers.
The tension between management and private equity plus the state of the economy in the 1980s is captured in Other People's Money.
America celebrates its innovators. When Steve Jobs passed away, millions held vigil and thousands wept. Jack Dorsey and Drew Houston sell out MIT. A picture of President Obama chatting with Mark Zuckerberg goes viral. In short, Americans love people that make things that change the way we live our everyday lives.
Financial innovators, on the other hand, do not enjoy the same love and respect. At best, innovators in finance make a lot of money and have tons of fun but don’t become household names. Arthur Rock, for example, should be as well known as Gates, Jobs and Zuckerberg. After all, he created venture capital – the tool that enabled Microsoft, Apple and Facebook.
At worst, financial innovators are reviled as fat-cat villains. Look no further than the topic du jour: Mitt Romney and his private equity background.
It’s easy to demonise people that “don’t build anything” and “make money on the transaction.” But the bad rap on private equity is misguided. Private equity was an important financial innovation and a key factor in the productivity gains and technology boom that began in the 1990s.
Before going any further, this blog is NOT an endorsement for Mitt Romney. It’s simply a look at the overall private equity market, and not a judgment of any specific deals done by Bain or any other firm.
This Machine Kills Conglomerates
Following World War II, American companies enjoyed nearly three decades of growth. At home, Americans consumed American-made goods. There were no German or Japanese or Chinese imports. These nations were decimated during the war and were rebuilding. And guess which economy provided the equipment, materials and services for the rebuilding? America. In short, America was #winning.
This period saw the rise of the conglomerate. According to The New Financial Capitalists by George Baker and George David Smith, three factors led to conglomerations. First, companies became bloated and staid in light of no competition. Second, ERISA (passed in 1974) limited the amount of money pension fund managers could invest into a single company. As a result, pension funds held a small number of shares in a large number of companies. Such a structure fosters passive – not active – shareholders. Lastly, antitrust rules made it difficult for two companies operating in the same industry to merge.
To put it all together, managers who face no threats from the outside (competitors) or the inside (shareholders), and who do not want to ruffle the feathers of anti-trust authorities, have only one option with excess cash: buy businesses in completely unrelated industries. It was this formula that led oil industry giant Mobil to acquire Montgomery Ward, a retail chain.
Private equity and the leveraged buyout were the change agents that dismantled conglomerates and realigned management with ownership. In its simplest form, a buyout works like this. An acquirer like Bain buys a target company using cash from its fund and debt from either a bank loan or a bond issuance. The target company’s assets serve as collateral for the debt. So a company worth $10 would be purchased using $1 of cash and $9 of debt.
Debt is the secret sauce. When a company has an obligation to meet, it must trim the fat and only make sound investments. That means no more corporate jets, lavish headquarters or underperforming divisions bought for the purpose of Empire Building. It means investing in projects with expected rates of return above the companies cost of capital. I equate LBOs to a mortgage. A person who takes on a mortgage will watch his or her money more closely and make financially sound investments -- one hopes, at least.
Private equity affected all enterprises in the economy. In order to avoid a takeover, management proactively levered up. (A company that already has debt cannot take on more debt to do a leveraged buyout.) In the end, American companies got leaner and more focused. By the 1990s, the LBO dividend began to pay-off. Companies invested soundly into R&D and process improvements, which in turn improved productivity and helped fuel the information technology revolution.
In conclusion, private equity isn’t perfect and it isn’t always pretty. The anger over compensation and taxes is understandable; private equity managers charge a 20% fee on profits earned, which is taxed as long-term capital gains (15%) as opposed to income or a bonus (35%). Partners in private equity firms also use debt to extract dividend payments for themselves; in some cases, these payments are too burdensome and good companies are forced into bankruptcy. Overall, however, private equity is a tool - though sometimes blunt - that moves the economy forward.
The best part about being in the start-up community is watching other start-ups. Almost every week, I learn about a new company that stops me in my tracks and makes me say, “Damn, that is so obvious. ABC company is going to forever change the way we do XYZ.” Here are three companies that have given me this reaction.
Venture capital was created 56 years ago. Before Eugene Kleiner’s shot-in-the-dark letter that landed on Arthur Rock’s desk, there was no institution for funding smart people with new ideas. That changed when Rock connected Kleiner and 7 other colleagues with Sherman Fairchild. Fairchild invested $1.5 million into the 8 transistor scientists to create Fairchild Semiconductor. Fairchild Semi was a success, at first, but soon the founders left because they did have enough equity. Two Fairchild employees - Robert Noyce and Gordon Moore - went on to found Intel. (To learn more about the fascinating history of VC and The Valley, check out this interview and the movie Something Ventured.)
Venture capital was a tectonic innovation in finance. But in the last half century, not much has change: VCs raise money from Limited Partners and invest in young, un-established companies with mountains of potential. In fact, the major innovation has been the rise of secondary markets like SharesPost and SecondMarket. These exchanges give shareholders of private companies liquidity, which is great. But these markets have not changed the fundamental way in which early stage ideas get funded.
The way that VC offered equity financing for early stage companies, Kickstarter offers working capital finance. This is huge. Before Kickstarter, working capital finance was restricted to established companies that had good relationships with banks. Now, a company with a novel product idea can create a Kickstarter campaign and pre-sell units. Since the company receives the money before shipping the product, they have capital on hand to deliver the promised product.
In short, Kickstarter gives early stage entities a form of finance that did not previously exist for them. The key question is will Kickstarter launch a billion dollar business? Naysayers say no way; Kickstarter is for crafts and movies. I say, if Kickstarter was around in 1976, Jobs and Wozniak would have created the “Apple 1” campaign.
Look at the data. Texting is on the rise; voice calling is on the decline. Recognizing this, TalkTo created an app that allows anyone to text any question to any business. Want to know if Whole Foods has your favorite microbrew? Launch TalkTo, select Whole Foods, and shoot off a text. Running late for a dinner reservation? No worries; TalkTo has your back.
I was in New York City this weekend and used TalkTo half a dozen times. It worked flawlessly. I was able to get a restaurant reservation, change said reservation, and double check that we would be seated outside.
Within one day, TalkTo inserted itself between me and every business that I interact with. In other words, TalkTo -- not the restaurant, bank or hotel -- owns the relationship. This is incredibly powerful: owning the customer relationship is the holy grail in business. In the insurance industry, for example, brokers and underwriters constantly struggle to own the policyholder relationship. Owning the relationship enables companies to better understand customer needs and ensure quality interactions, leading to customers that stay longer and buy more.
By building a simple app that delivers as promised, TalkTo is poised to change the way that people find information about and interact with companies. What company recently did that? I’ll give you a hint. It starts with a “G” and ends with an “oogle.”
I love services that create marketplaces. The two most recent examples are Airbnb and Uber. Airbnb looked at the world and said how can we connect supply (people with spare beds) with demand (people looking for an inexpensive place to stay). Uber did the same thing, connecting underutilized Town Cars with people seeking reliable and convenient car services.
GigWalk is connecting businesses that need market research with people looking to make a few dollars. A brand - think Colgate, P&G, etc - needs to understand (or audit) how its products are being placed on the shelf at retailers. The brand could send in a dedicated “secret shopper,” which is costly and logistically challenging. Or, the brand could use GigWalk to push an alert to anyone in the area and ask them to simply take a photo of the Dental Section.
I particularly like GigWalk because it is an everyday product. A simple trip the grocery store or Starbucks or a restaurant could net a GigWalker a few dollars. In short, GigWalk looked at the world and said how can we use existing tools to mobilize people to solve a business challenge.
A couple weeks ago, I headed into the backcountry of Banff National Park for a 5 day, 40-mile hike. This was my fourth major hike since 2004, and perhaps the most grueling due to the weather. Eight hours into the hike, the skies opened and did not close until the final morning. So as I slogged through the mud, trying not to step on Grizzly Bear paw prints, I asked myself: why am I schlepping a sixty-pound backpack in cold, driving rain and at the risk of a fatal attack by 500-pound mammal?
One reason is that hiking provides an opportunity to see different aspects of life in new ways. During this trip, I realized that backpacking is a lot like launching a startup. Below, in no particular order, are the reasons why.
Limited resources fuels innovation
A hiker’s resources are limited to what he can carry (tent, sleeping bag, clothes) and what the forest provides (wood, water). If you forget – or lose – something, it is gone and you better hope that you don’t need it. After a few days of living with such constraints, the mind becomes incredibly inventive. During this trip, for example, we rigged up a sturdy multi-level clothes-drying rack using nothing but branches and logs. During a past trip, we crafted a way to drag our packs across snowfields in order to limit falling through.
All businesses but especially start-ups are resource limited. Capital, talent, and time are in short order. As a result, start-ups constantly innovate not only in the products they offer but in the way they operate. My favorite story of innovating to survive is Airbnb, which designed Obama O’s cereal and sold the collector-edition munchies to attendees at the Democratic National Convention. They raised $25,000 to fund their start-up.
As start-ups mature, however, they must shed the patchwork operations that they "innovated" during the lean years. Relying too heavily on Excel – or Google Docs – is a prime example. When resources are limited, it is acceptable to cram everything from salary planning to project management into a spreadsheet. As the company proves longevity, it must invest in the proper processes and technologies in order to support sustainable growth. Not doing so is equivalent to using an open fire and rack of branches to dry clothes, despite being out of the woods and having access to an electric dryer.
Risk management takes on a whole new meaning
Hiking is a risky endeavor. Any number of events can happen on the trail, including getting lost, injuring yourself, running into an aggressive animal or getting hit with a major weather event. These events can easily result in death – and it is usually a slow and agonizing death. But they are all avoidable. With the correct maps and trail descriptions and an ability to read a compass, the risk of getting lost is greatly diminished. (Heck, you can even bring a GPS that pinpoints your exact location, but that takes the fun out of it.) Talking on the trail and hanging your food 100-plus meters away from your tent are both actions that reduce the threat of a bear attack. Throw in bear spray and a general understanding of what to do in the event of an encounter and you’re in pretty good shape. Lastly, reducing injury is common sense: never jump; be careful with your knife and around the fire; stay hydrated, dry and warm; carry a first aid kit.
Risk management is dependent upon understanding the probability and severity of an event occurring. Once you understand these two factors, you can triage mitigation. As I walk through the woods, I’m constantly calculating and triage-ing. During this trip, for example, I calculated the risk of a bear encounter to be moderately high; by my calculations there was one Grizzly for every 10 square miles of habitable land, and we were traversing 40 miles. On the other hand, the risk of getting lost was low; the trail was through a valley with steep, rocky mountain faces on each side – the equivalent of bumpers on a bowling alley lane. I adjusted my behavior accordingly.
For start-ups, risks lurk around every corner: system outages, patent trolls, legislatures, unethical employees. A founder’s job is to identify, triage and manage these risks. Unfortunately, though, risk management is often sidelined during the frenzy of creating a new product and winning customers. After all, it is difficult to pull oneself away from the exhilarating and vital task of crafting the next generation of a product to draft a contingency plan that may never be used. Founders also have a difficult time shifting money away from R&D and sales and towards risk management expenses like insurance, lawyers, and monitoring systems.
Remember how fortunate you are
Hiking helps remind me how fortunate I am. I have my legs to carry me, my eyes to take in the vistas and my ears to hear the sounds of rushing mountain waters and high-pass winds. I have also chosen to live a “pre-civilization” lifestyle by sleeping on the ground in a flimsy shelter, pumping water, keeping warm and cooking with fire, and placing myself lower on the food chain. For millions of people this is not a lifestyle choice; 884 million people, for example, do not have access to clean water. Lastly, I’m reminded of the military, who basically hike through the most treacherous places on earth – from the mountains of Afghanistan to the jungles of Vietnam – with one additional risk: enemy fire.
Start-up founders are also fortunate. In many ways, founders are responsible for their destiny. They envision an opportunity and have the courage and talent to execute upon that vision. However, there are factors outside of their control that increase the likelihood of success. Health and physical appearance is one example.
Success is also dependent on origin of birth and residency. Over the last 400 years, the United States has developed systems and institutions that foster entrepreneurship. In the United States it takes 6 days and only a few hundred dollars to establish a legal corporate entity, whereas in Brazil it is four month journey that could cost more than one thousand dollars. Throw in bankruptcy laws that do not discourage risk taking, a court system that upholds property rights and legal contracts and a functioning insurance market, and innovation flourishes. In short, an entrepreneur operating in the United States has a much greater chance of success than his equally talented counterpart in just about any other part of the world.
Stayed tuned to hear the insights from Hike 2012, which will hopefully be in Glacier National.
I'm the Founder and CEO of Peak Support. This blog is my take on early-stage companies and innovation. Every so often, there may be a post about culture, networking, family -- you name it. After all, what is a blog if it isn't a tad bit unstructured.