What I Learned from the Founders of Floodgate and Benchmark (Part 2): Proprietary Power & Inflection Points
This was an exceptional week where both courses focused on many overlapping concepts. In particular, founders of both firms emphasized the importance of creating value prior to creating scale, and the importance of being non-consensus and right. Also, they reiterated that the main reason startups fail is due to lack of market, not failure to execute.
Prime Movers Wanted
We had the Founder and CEO of Okta (Todd McKinnon) join the class on Monday afternoon — his company went public on the NASDAQ three days prior (pretty cool)!
“When forming a company, do something crazy that’s not actually crazy.” –Todd McKinnon (Okta, Founder and CEO)
It took Okta three years to reach product-market fit. According to Todd, “Sometimes you have to believe, even if you don’t believe.” He went on to say that in Okta’s early days the question was, “Can we get a customer?” Then after getting one customer the question changed to, “Can we get 10 customers?” And finally to, “Can we go public?”
Todd had convection that the cloud would change the game. While conducting customer development the concept of “identity management” and “single sign on” kept coming up and ultimately led them to pivot the business. Although it took years to reach product-market fit, Todd believes that much of this time was spent “waiting for the market to mature.”
Proprietary Power Overview
A founder must do the things necessary to avoid competition (especially in a company’s early days when a startup is at its frailest state). Being consensus and right leads you to mindless competition, so a founder must strive to be non-consensus and right (more on this later from Andy). According to Mike & Ann, there are seven main sources of proprietary power:
- First mover advantage — the weakest of all advantages given it doesn’t prevent competition for very long. (MySpace vs. Facebook)
- Unique insight (a.k.a. “secret”)— no/few competitors given its non-consensus nature and that others believe the secret to be crazy (Copernicus’ model placing the Sun at the center of the universe rather than the Earth); hard to defend from copycats once insight becomes consensus.
- Breakthrough technology — significant technological barriers to entry thereby preventing most competition.
- Network effect — A product that’s more valuable to a customer every time a new customer uses it (a.k.a. demand side economies of scale); Relies on Metcalf’s Law (the value of network is a function of the square of its nodes); Network effects ≠ virality; If building a network effects business, it’s important to think like a network operator. (Deep dive from a16z here.)
- Disruptive innovation — A go-to-market strategy that incentivizes incumbents not to compete with you (e.g. Tesla vs. BMW, telephone vs. telegraph); Also associated with the innovator’s dilemma; Could be top down or bottom up.
- Early market monopoly — Owning an entire niche with breakout potential is better than taking a small slice of a large market; facilitates early value creation rather that early growth.
- Defensible market position — Central to Warren Buffett’s investment philosophy, “In business, I look for economic castles protected by un-breachable moats.” (Coke, Apple, etc.)
Miscellaneous Quotes and Concepts:
· “Part of having a secret is being a heretic. (e.g. Copernicus stating that the sun, not the Earth, is the center of the universe.)” –Mike
· “Being provocative is a strategy to attract people who believe in your secret and repel people who don’t.” –Mike
· “If everybody agrees with your idea, you are consensus and right and therefore have over 20 competitors.” –Mike
· Market risk and technical risk have an inverse relationship
· Being the 1st mover isn’t always a good thing.
· Time to market doesn’t matter, what matters is time to market volume.
· The best companies focus on value before growth.
· “We invest so early that we mainly ask, “Do we believe in the team and the insight?”” –Mike
Aligning Startups with Their Market
“First mover advantage is a myth — it’s first to product-market fit.” — Andy
The job of a startup is to discover its market. In this phase of the business, discovery trumps planning. Startups only have a chance to succeed if they find their desperate customers — customers who will do nearly anything to utilize the product in question. According to Andy, the entire course can be summed up in one sentence, “What do you uniquely offer that people are desperate for?”
Start with an Inflection Point
When starting a startup it’s critical to start with the inflection point and iterate on the final market. According to Andy, starting with the market and iterating on the “what” is a recipe for disaster. He also believes that inflection points “find you” you don’t “find them” and that market inflections are only made possible through technology inflections (e.g. Uber was only made possible due to the proliferation of mobile platforms).
The critical milestone a startup must achieve in its early days is validation of its “value hypothesis.” Without this, nothing else matters. This process often results in surprising insights that assist in further refining the value hypothesis.
It’s difficult to understand what customers are truly desperate for, and the best way to gain this understanding is by “getting out of the building” and talking to prospective customers. Surveys are good tools for existing markets but not useful in assessing new markets since consumers are conditioned to like things they already know. Also, recognize that hearing a “maybe” is worse than a “no” during your hypothesis testing. Ultimately, you haven’t fully proven your value hypothesis until you’ve succeeded in generating organic exponential growth.
Value of Predictions
The only way to gain outsized returns is to be non-consensus and right. It’s not enough to be right and consensus because consensus results in the majority of returns being arbitraged away. (Suffice it to say, it’s always bad to be wrong.) If everyone likes your idea, you are consensus, and too late.
Miscellaneous Quotes and Concepts:
· Resist the temptation to add features. If customers don’t like your MVP, they wont like it with more features!
· “The best VC’s take scale risk, not value risk — angels take crummy bets because they take on both risks.” — Andy
· “The best VC’s want proof of the value hypothesis, not the growth hypothesis.” — Andy
· “Investors are always six months behind the market.” — Andy
· Lack of competition is the ultimate form of non-consensus.
· What kills companies is lack of market, not execution.
· High market risk and low technical risk are a terrible combination.
· Lean startup method = scientific method applied to business.
Observations / Takeaways:
Finding product-market fit is not as easy as it sounds, and most companies fail because they aren’t able to align with a desperate market. By utilizing some of the principles discussed above, a founder greatly increases his/her chances of building a successful business.
Startups that begin by first targeting a market, then building a solution to fit that market’s needs, are at a distinct disadvantage to those that begin with an inflection point then identify the market. (I tried the former and was unsuccessful — go figure!) It’s even better if that inflection point leads to a non-consensus view that ultimately ends up being correct.
I haven’t met very many people who are non-consensus (contrarian) and correct on a frequent basis. However, I am lucky to know many people who persevered through seemingly insurmountable odds to become Olympic Gold Medalists and Navy SEALs. In that sense, I view both of these groups to be non-consensus — those who “made it” did so in spite of many saying it couldn’t be done. When you have an insight, or a belief you know to be true, take a lesson from these communities that I’m honored to be a part of: don’t ever give up.
Check out part 3 here!
