Startup 121: Lessons for the Recession from Rice Krispies
The past few months have been, how shall I say, pretty crappy and have caused lots of cut backs for most startups (and companies of every size). Mostly, this has meant laying people off, cutting expenses, and generally “battening down the hatches to weather the storm”.
I randomly had several conversations with people on the topic of what a startup (or any organization) should do in times like these and some basic things came up each time:
- Measure to manage
- Mix it up
- Take calculated risks
Measure to Manage
Today, months into this recession, no one would argue that the economic outlook is negative. However, often times forecasting is challenging to say the least and usually only accurate in hindsight. I used to joke with our Board whenever I presented a financial plan that the only thing I could guarantee was that we would miss the numbers. That did not mean the results would be worse, but that I was positive we would not hit the plan to the penny. We would be roughly right, which in the words of Kenyes, is better than precisely wrong.
By Darren Hester
It turns that we were in good company as the record for long term forecasting of macro economic indicators by the “experts” is actually only roughly right in the near term and not so predictive in the long term. Just like a startup’s financial plan.
The Federal Reserve released a paper at the very beginning of the recession (coincidence? conspiracy? hmmm…), which analyzed historical accuracy of past economic forecasts such as the Gross Domestic Product (GDP see wikipedia).
OK, I admit, it’s little nerdy thinking that others would be interested in Average Root Mean Squared Forecast Errors but…
The report basically shows that most forecasts of growth are only good one or two quarters out, and beyond that, “…uncertainty about the economic outlook is considerable.” So if it’s hard to forecast a problem, what should a startup do?
In today’s world, measuring things is actually easier than it has ever been – Page views, Click Throughs, Conversion Rates, Leads, Registrations, Trials, you name it. Startups are actually pretty good at using data and all should have a set of good metrics to manage their business (See previous post If you don’t know where you are doing, well you’re lost).
In a startup this is usually easier than for big companies, but on a business by business basis, this should be possible even in the largest of companies but is something most don’t do well or at all. And it’s another reason why startups kick corporate booty. Let’s face it, startups are, well, smarter.
Now, all that being said, metrics need to be leading indicators for what will likely happen in the future as opposed to only lagging indicators. At Vontu, since we were doing enterprise sales (i.e. 9 months average time from a first prospect meeting to closing a 6 or 7 figure deal), even after having some of our best quarterly sales results, which is a lagging indicator, we were worried about the future because leading indicators, such as product evaluations (or as we called them, risk assessments), were not tracking to our historical averages. Team attrition is another example of a lagging indicator of a problem, that is to say if people are leaving, the problem already exists.
Now it sounds like I am talking out of both sides of mouth. And I am. Even though the Fed is not good with long term forecasting, having 6 months of visibility is still better than none. To know you have a problem (or an opportunity as the case may be), one can not focus enough on leading indicator metrics. And if you did not have the right metrics in place at the start of this recession, consider putting them in place now as you will also be a step ahead in predicting when to accelerate investment as things improve.
Mix It Up
Most startups (and large companies) made big people changes over the past 6-9 months typically in the form of cost cutting and layoffs and sometimes quite significant layoffs both in numbers and percentages. While layoffs are big changes affecting the lives of many people yet help in improving the health of the company for the short term, they are not about dramatic changes in leadership for the long term.
In my opinion, down turns are as good a time as any to make dramatic people decision that you have either been dreading or avoiding for whatever reason. First, there is already so much disruption that throwing some more into the mix won’t make much of a difference. Secondly, it is somewhat easier to hire great people given the macro-economic turmoil and increased unemployment. And lastly, everyone on the team already knows who is not performing. You as a manager and leader are usually the last to acknowledge the problem, yet the team expects you to make these tough calls.
Expectations for business results are low today so take the time to make the big people changes and if things get a little messy in the short term, but it’s all relative to the ongoing mess which already exists. And who knows, they may actually be better too.
Take Calculated Risk
My friend Phil forwarded me the New Yorker article “Hanging Tough” by James Surowiecki about what strategy some companies followed during the Great Depression. An example used two competitive cereal makers, Post and Kellog, and how chose very different market responses. Post did the standard cost cutting, yet Kellogg invested in advertising and new products and as a result, “Snap, Crackle, Pop!”, Kellogg became the dominant player it is today. For the same reasons it is a good time to start a company today (less competition, easier to hire, leverage the inevitable economic upswing), companies should be thinking about investments to be made today as the economy is at its lowest point.
In general, if one keeps an eye on the long term, one should always be making investments. Unfortunately, as the New Yorker article suggests, uncertainty overtakes risk taking. This short term uncertainty causes people to focus on what they can control, e.g. costs, as opposed to making smart investments for the future.
Yet history has shown that even during the Great Depression, companies that made good investments did well. Even the stock market came back more quickly than people remember.
At a recent presentation by Professor Jeremy Siegel from Wharton, he had a slide which stated, “On average, for the seven largest gaps [in performance relative to trends] over the past 145 years, the market has rallied 24% in the following year, 21.4% per year over the next 3 years, and 18.4% per year over the next five years.”
As suggested in the New Yorker, while most people are “battening down the hatches”, you might want to invest as the others might actually just might miss the boat.
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Econ 120: What Taxes and Splitting the Restaurant Bill Have in Common
Since it’s tax day and all, I figured why not post something that I am sure will spur lots of conversation (or maybe controversy?)
There are so many (mis?)perceptions on the tax system, I decided to get some facts about how it all works, or at least, to see what of the rhetoric is true. In particular, in most of the press and political speak out there, the common perception is:
- Tax cuts only benefit the “rich”
- The “rich” actually pay fewer taxes
Darren Hester
Now, without commenting on what the tax system should look like I figured it would be interesting to share a funny story to help explain why people perceive the first point and then share some data from the Congressional Budget Office on whether the the top income earners actually pay fewer taxes. (By the way, I am a first generation American and the son of Italian immigrants. My grandfather came through Ellis Island when he was 16. In other words, I come from very humble beginnings and I figure that might help in any emotional responses this post might trigger.)
Splitting the dinner tab
The following is a story about if we split the dinner tab like we split the tax burden and helps explain the misconception that tax cuts only benefit the wealthy. This parable has floated around the internet in various forms and no one is sure of its true origin though some trace it back to Don Dodson and a letter to the Chicago Tribune. Anyway, the story goes like this.
Suppose that every day ten men go to a restaurant for dinner. The bill for all ten comes to $100. If it was paid the way we pay our taxes (Editorial: this is not exactly how we pay taxes as you will see below, but its generally indicative of how it works), the first four men would pay nothing; the fifth would pay $1; the sixth would pay $3; the seventh $7; the eighth $12; the ninth $18. The tenth man (the richest) would pay $59. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement until the owner threw them a curve.
0 + 0 + 0 + 0 + 1 + 3 + 7 + 12 + 18 + 59 = 100 cost of dinner
“Since you’re all such good customers, he said, I’m going to reduce the cost of your daily meal by $20.” Now dinner for the 10 only costs $80.
The first four are unaffected; they still eat for free. Can you figure out how to divvy up the $20 savings among the remaining six so that everyone gets his fair share? The men realize that $20 divided by 6 is $3.33, but if they subtract that from everybody’s share, then the fifth man and the sixth man would end up being paid to eat their meal.
The restaurant owner proceeded to work out the amounts each should pay under the same assumptions: Now the fifth man also paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, and the ninth paid $12 leaving the tenth man with a bill of $52 instead of $59. Outside the restaurant, the men began to compare their savings. “I only got a dollar out the $20,” complained the sixth man, pointing to the tenth, “and he got 7!”
0 + 0 + 0 + 0 + 0 + 2 + 5 + 9 + 12 + 52 = 80 reduced cost of dinner
“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got seven times more than me!”
0 + 0 + 0 + 0 + (-1) + (-1) + (-2) + (-3) + (-6) + (-7)= (-20) savings on dinner
“That’s true,” shouted the seventh man. “Why should he get $7 back when I got only $2? The wealthy get all the breaks!”
“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor.”
And that is why there is a perception that tax cuts benefit the highest income earners versus the lowest quintile. It’s because the percentages are already progressive, that is that the highest income earners pay a greater share of tax as well as a greater percentage of their income.
Just the facts
I am sure some of you are saying, “that’s not true” or quoting Warren Buffet who said something to the effect that his tax rate is lower than that of his secretary. Now I don’t know about Warren’s tax rates, but I figured a few charts would at least get the facts out there.
All the following data is from the Congressional Budget office using the latest tax year made available which is 2006. The data goes back to 1979 for folks that are interested. Links to everything are at the bottom of the post.
To start, I wondered what is the effective tax rate for various income levels. Do the rich pay a lower tax rate as Warren Buffet suggests?
The first chart is the Effective Tax Rate for all federal taxes paid (Income, Social Insurance (Social Security, Medicare, et al), Corporate Income Tax, and Excise Taxes. The second chart is just income taxes.
Effective Federal Tax Rates (2006). Source: Congressional Budget Office
Effective Federal Income Tax Rates. Source: Congressional Budget Office
I think the data shows pretty clearly, that contrary to common perception, the top income earners pay a greater percentage of their income. That is to say, the tax system is quite progressive both in total taxes and even more so with respect to income. Approximately, 40% of households pay no taxes on their income or actually receive additional money above their income.
The second question I wondered is on a dollar for dollar comparison, how do different income levels pay as a percentage of their total income. This graph is a comparison of total income earned compared to total taxes paid.
Share of Total Before Tax Income and Total Federal Tax Liabilities (2006). Source: Congressional Budget Office
This too shows how the highest quintile pay a higher share of the total tax liabilities in comparison to their income. Again, the system is progressive.
So what?
Of course the more interesting question for discussion is if this is the best and right way for taxes to work. Without tackling that question today, one other fact to share. Prior to the 16th Amendment being passed in 1916, it was unconstitutional to apportion direct taxes in any way other except equally based on the census. So is it right? Is it the best system? I will leave that for a future post but hopefully we can all start using the real facts versus common misconceptions.
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Source for chart data: Congressional Budget Office
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Startup 119: Why Startup Innovation Kicks Corporate Booty
I recently had coffee with David, a friend from college that was an advisor at Trio Development and an early employee at Connectify. As he now works in the incubation group of a large enterprise software company, he was lamenting about how hard it is for large corporations to innovate. That got me thinking about what it is about startups that leads them to “out-innovate” large corporations.
It ain’t about the technology
To start, I believe innovation is simply about creating significant new value though some combination of unique products, processes, and services. I do not think innovation is solely about creating new products or technology. That is simply invention.
While I am not an innovation scholar, my experiences suggest that innovation happens more easily inside of startup because they tend to have the right combination of:
- People
- Freedom
- Failure
It’s the people, stupid
Startups out innovate first and foremost because they build a complete team of dedicated individuals that eat, sleep and breathe the startups goals, which frequently include a goal to kick a large corporation’s you know what.
A complete team means “customer success oriented” engineers and product managers who spend lots of time working directly with customers; “take no prisoners” marketing people that are all about getting the startups message out and driving customer demand; “meat eating” sales people that make their quota solely on the success of the startups innovation; support and services people that are maniacally focused on making customers successful; human resources teams focused on hiring and engaging the best and brightest; and so on through the rest of the startup. It is also about a culture that is centered on the process of innovation as opposed to the vast majority of people in a corporation that are about the existing status quo.
Unfortunately, it seems that most large product and technology corporations think innovation is about having a team of engineers developing some new cool thing (again, that’s invention). And the thinking goes that once that new cool thing is developed then their hundreds or even thousands of sales people and vast marketing organizations will make it successful. The truth is that this rarely if ever leads to any new high growth businesses.
Corporate CTO’s organizations tend to be very disconnected from customers and only dabble in invention. Core product development teams are focused on improving or worse, fixing, their existing product. Corporate marketing teams love peanut butter too much. Yes, peanut butter. They take their marketing dollars and spread them thinly across lots of projects with little to no strategic thinking or accountability. And sales organizations rarely know how or are incented to sell anything but the company’s best selling products. The list of people challenges to innovation in a large corporation goes on and on. And when it comes to process, the place where lots of value can be created inside of large companies, the challenges are even more immense.
Startups are successful at innovation by first building a completely dedicated, funded and accountable team which takes something all the way from product or service creation through to selling and servicing the customer. And not only is that team focused but they have the freedom to execute in the best way possible to be successful.
Freedom
Teams need freedom to re-evaluate everything about a business from people, to process, to product and services. This freedom is often to do things that are radically different and often times competitive with the status quo of existing people, process, products and services with a corporation.
Salesforce.com is a great example for why giving a team freedom is unique in a startup and and hard to do inside a large company. Salesforce.com was started in 1999 at the height of the “dot com” bubble by a group of former Oracle executives who believed in a new way to deliver software applications. They were not trying to build some new product, but rather they thought that customer relationship management (CRM) software to manage sales process and customers was best provided not as a software application but as a service. (To learn more about software as a service, here’s some info at wikipedia.)
Their whole marketing campaign in the early years was “No Software”. They used that slogan everyone from their website, to advertising, to buttons they handed out at trade shows. And they were wildly successful because the time to value versus installing the market leader at the time, Siebel’s CRM software, was much greater for Salesforce.com.
It is unlikely they would have been successful with this innovation inside of a company like Siebel. Can you imagine one of the top software companies in the world giving a team the freedom to market a new way to deliver its services under the moniker “No Software” when the vast majority of the company’s revenue came from selling software?! No way. It turns out that Siebel did try software as service when they released a competitor sales.com though it ultimately failed and Siebel was eventually acquired by one of the largest software companies, Oracle. (Interestingly, Larry Ellison, Oracle’s CEO, has been an investor in some of the top SaaS companies which compete with Oracle including Salesforce.com and Netsuite)
The inability to give teams complete freedom is one of the reasons that innovation in a large corporation is hard. Once you are successful with an innovation, for example Siebel selling CRM software, it’s hard to put your own business at risk with new innovations such as Salesforce.com selling their solution as a service. Innovation can often not only threaten but require massive change to products, people, or processes.
Startups have the freedom to do things differently and that freedom often leads to innovation. While innovation can lead to massive value creation, more often than not, efforts to innovate actually fail. And failure is another reason why corporations do not innovate well.
Failure
We all know about the successful ones – the startups that go on to create new markets, big business and often times big companies. Some that come to mind are Google, Salesforce.com, VMWare, Amazon.com, and many more. However, the fact is that for every startup that goes on to create a new market, business or company, there were 10 or 20 times as many failed startups. And this failure is needed for innovation, yet it is not something corporations are set up to do. They are not likely to take hundreds of millions of dollars and have the majority of 50 some odd projects fail with the never-ending pressure of meeting the quarterly expectations of Wall Street.
The venture capital model basically is, for example, that out of a group of 50 investments over a 5-10 year period, there will be a few if not even just one big hit that provides for the vast majority of value creation. Think Google, eBay, Salesforce.com, etc. that end up with multi billion dollar market caps. Then there will be a few successful companies that are often acquired by larger corporations for several hundred million dollars. Think VMWave which was acquired by EMC before being spun out years later, Pure Digital, the makers of the Flip video camera acquired by Cisco and even Vontu by Symantec. Then there are basically the remaining 80+% that either simply fail or somehow return some small amount of the initial investment.
You need to invest money in lots of projects and only a few will succeed. Corporations cannot typically afford to do this. Which is why the most common route for successful innovation for large corporations is through acquisition of these companies. It is far less expensive and risky to acquire an ongoing business that has proven itself then to invest in the 50 different ideas to try and find one that works.
David and Goliath
While, there are lots of other needed ingredients for innovation to occur, having the right dedicated people with the freedom to try lots of things including the ability to fail, is a key foundation for startups – and something around which corporations are not organized. This foundation is one of the main reasons startups beat corporations in the innovation game and has been the case for decades. Until corporations figure out how to replicate this, my money is on startups to be the continued source of innovation for years to come.
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Some other interesting posts related to this topic:
It’s the people, stupid and It’s the people, stupid, part II. on the importance of people.
Following the puck can give you a black eye. on competing and innovation.
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