Class 4 Notes Essay — Reid Hoffman, John Lilly, Chris Yeh, and Allen Blue’s CS183C Technology-enabled Blitzscaling course

Here is an essay version of my class notes from Class 4 of Stanford University’s CS183C — Technology-enabled Blitzscaling — taught by Reid Hoffman, John Lilly, Chris Yeh, and Allen Blue. Errors and omissions are my own. Credit for good stuff is Reid, John, Chris Yeh, and Allen’s entirely.

This class was taught by Ann Miura-Ko — one of the co-founding partners of Floodgate — accompanied with a Q&A by John Lilly afterwards.

I wasn’t actually able to attend this class in person so a big thank you to Ryan McKinney and Noor Siddiqui for helping to record this class and share the audio with me.*

Video of the course (Notes are below)

I. Thunder Lizard Theory

Thunder Lizards is a term Ann Miura-Ko and her partner Mike Maples coined and is the central theme for their investment fund — Floodgate. It’s their story on what codifies great entrepreneurs and great startups. The story goes like this:

• The Thunder Lizard was inspired by Godzilla to represent entrepreneurs who have achieved tremendous scale.
• Thunder Lizards are born from radioactive atomic eggs, there is just something different about these creatures from day zero.
• The Thunder Lizard endures a long and tumultuous journey across the Pacific Ocean, enduring many challenges along the way. Sometimes they will take a break in Hawaii.
• Eventually the Thunder Lizard makes it to their end destination in San Francisco and emerges from their journey with an attitude and wreaks havoc onto the city. A Thunder Lizard can shoot laser beams from their eyes, eat trains, eat ships, etc.
• The Thunder Lizard grows up to completely dominate their territory and completely destroys any competition that gets in their way.

How this story applies to entrepreneurs is:

• There is a certain type of founder who can take his/her advantages and turn it into truly disruptive power.
• These founders seek to minimize organizational and technical risk.
• These founders achieve product market fit — they have a pull from the market and a good feel for their product.
• These founders like to avoid or destroy their competition.

II. The Rarity of Thunder Lizards

Thunder Lizards are very rare. Between 1980 and 2012 there were 3,000 companies which IPO’d onto the public market.

Of these, only 17 have achieved more than $4B in revenue. These are the companies that are truly legendary, but it is incredibly hard to become one.

Even getting to IPO is rare in the first place. In every given year there are only ~25 companies which will exit for more than $500M. These are the true odds of creating a great company.

III. The Value Stack of Thunder Lizard Companies

Ann Miura-Ko and her partner spend a lot of time thinking about how they can spot these types of companies early and what groundwork needs to be laid down to help these companies with future growth.

To help with their thinking they created a model called the “value stack” which helps them judge the companies they look at. The value stack is made up of these components:

1. Proprietary Power — The key insight of your product
2. Product power — Product Market Fit
3. Company power — Business model and company culture
4. Category Power — Defining your market

We’ll go through each one individually.

IV. Proprietary Power

Ann Miura-Ko spends the most time on this part of the stack because this is the most evident in the earliest stage of the company. Proprietary is the technical insight the product and company is built on top of.

For example, one of their portfolio companies — Ayasdi — came from the Gunnar Carlsson, a professor of mathematics at Stanford University. One of his grad students turned his theories into a product and then turned the product into a company. The company has over 25 years of research behind it.

Proprietary power doesn’t only stem from technical innovation, other examples include:

• Access to scarce supply — Ex. De Beers having access to diamonds.
• Creation of high switching costs — Ex. Keurig, once you buy the coffee machine you have to buy the coffee pods.
• Network Effects — creates lock-in for both consumers and suppliers. Ex. LinkedIn having network effects on your professional identity.
• Authentic team — Ex. Lyft and their founding story. One of the founder’s professors showed that every period of innovation involved a change in the transportation industry — trains, canals, highways, etc.

Question from Audience — In today’s world the barriers to entry are lower — how does this change your thinking about technical innovation?

Building a product is easier now than ever, but developing key insights is harder than ever before. You need to believe in something which no one else knows about or no one believes in.

For example, the founder of Veeva Systems said — every great startup has one fundamental assumption that has less than a 50% chance of being correct, but will give you a 20x advantage in the market. For Veeva Systems their bet was it was possible to build a $1B company on top of Force.com (the Salesforce platform). Everyone at the time thought he was crazy but he proved it was possible.

V. Product Power

Product power is the ability to achieve product market fit. Many startups are never able to turn their technical innovation into a real product. Many startups are a technology in search of a problem.

Product market fit has been talked about a lot but very ill-defined. Some people will say “if someone in the world likes your product, that is product market fit” — this is just not true.

Product market fit implies — there is a large and growing market for your product and the demand literally feels uncontrolled.

For example, with Instagram — when they launched Instagram they purposely built their tech stack from day one to be hosted off their internal servers and onto AWS. Within the first 12 hours of launch, their usage outstipped all of their current demand of their internal services and needed to scale beyond what they ever thought was needed. The founding team had a good sense that this was going to be big from day one.

Typically if you are a founder asking the question — “do I have product market fit?” — this means you don’t have it yet. You would know it if you had it.

Question from the audience — Can you create a new market if you have a transformative product?

Yes you can but it’s much harder. The one example that comes to mind is VMware which created an entirely new market of virtualization which wasn’t there before.

The one type of company which is harder to immediately feel product market fit is marketplace businesses. The reason is marketplaces typically take a really long time to develop, its takes careful balancing of supply and demand, and it’s very easy to get the balance wrong in the early days.

Question from the audience — Can you test the market out for product market fit even before you create a product?

Yes, Ann Miura-Ko has helped Steve Blank teach a few courses around customer development which is exactly this idea.

It’s possibly to test out various customer hypotheses and try various experiments before having a product. Where this can go wrong however is customer development, which is much more of an art than a science.

It’s very difficult to know when the experiment was wrong vs. when the experiment was presented wrong and needs to be tweaked. At the same time true customer insights also typically come from not what you are expecting — but the things you notice.

For example, during customer discovery interviews, you shouldn’t just be looking for what you already think — but rather asking your customers what their life is like and what their problems are — then using this information to find the inspiration for your real product.

VI. Company Power

Company power is broadly broken up into a few pieces:

• The scalable business model which sustains your company
• The cultural values of your company
• The narrative of why your company exists
• The compensation model which develops and rewards talent
• Career paths for your employees
• The communication within your company and the culture around how you communicate.

Lots of “unicorn” companies today are still searching for their scalable business models and when you don’t have these pieces right — you will accumulate a lot of organizational debt.

For example sometimes later stage companies will realize:

• Why do I have these eight CEOs? — this is organizational debt.
• Why is our compensational model all messed up and not really rewarding our top performers ?— this is organizational debt.
• Why do our employees feel like there aren’t adequate career paths for themselves ?— this is organizational debt.

What we look for when evaluating early stage founders is — will the founder be open to thinking about these kinds of issues. What we are trying to understand is, if the founder will be the long term CEO of the company, they will need to grow into this position and really start understanding the organizational side of the business.

Question from audience — How do you notice these cultural and organizational issues at the early stage?

In the early stage, a good think to look at is — how good are they at early hiring? And what are they willing to give up to get the best people?

One of the companies we invested in has successfully hired great talent at some of the top companies around Silicon Valley, even during this highly competitive market. They way they do this is the founders have spent a lot of time thinking about who they want to hire, how they do interviews, compensation structure, etc. They think about these issues just as much as they think about the product.

VII. Category Power

The final part of the Thunder Lizard stack is the concept of category power. The ability to take all of the previous layers of the stack and convert these advantages to truly disruptive power.

One thing we have noticed is the best companies will spend the time to create a whole new category in the market for themselves, because they don’t want to compete on other people's terms. They want to be the only Thunder Lizard on the block.

For example, Netflix didn’t start out trying to be a better Blockbuster. They created their own separate category and then completely destroyed Blockbuster. Another example is Starbucks — who would have ever thought people would buy $5 coffees when other coffees at that time was selling for 50 cents. They created their own new category.

Category power is the ability for the founders to think about the language of the market they are going into, and how they define this for their company. If they are allowing the existing market to define who they are — we get worried about this.

Question from the audience — Can you create category power even before you have product power?

In theory you could, only because these two concepts are separate. Category power is more about how you internally look at yourself and talk about what you are doing vs. product power which is external.

VIII. Question and Answers with John Lilly

John Lilly: One question we have asked all of our speakers is, what can you safely ignore as a small startup. You need to be good at a lot of things but what can you ignore while you are 0–15 people?

Ann Miura-Ko: I think about this more as what you should focus on as a small startup. The priority as an early stage startup would be at the bottom of the stack — what is the unique advantage or insight you are building your product on top of? The product market fit will come later after your key insight of what your unique advantage is.

Between 0–15 people you really don’t need to think about career paths, titles, organizational structure, etc. All of these things come later.

Also while you are an early stage startup it's ok to incur technical debt. During this time period you really aren’t sure what is going to work and what isn’t going to work — the key should be emphasizing on moving fast and making quick decisions vs. making everything perfect.

The #1 thing during the early stage period is the speed of decision making and moving quickly.

John Lilly: To your point about authentic founders, do you think all founders need to have a compelling origin story? How do you tell if they are authentic or not?

Ann Miura-Ko: Personally I like to understand what is the tie in between the idea and why you are personally working on this — why do you have this unique insight?

One question we ask during every single pitch is — why you?

Authenticity can come in many different forms however. A few examples are:

• The problem could personally affect you, and you yourself could be the customer for the product.
• You could have worked in the industry and really understood the problem from an inside perspective.

These things are important because there is a moment in time in every startup’s life where you march through the valley of death. If this is your 1/10 startup idea, then you are more likely to flee during this time period.

Personally I would much rather back founders who care deeply about the problem they are solving and understand that this is the one thing they really want to do.

John Lilly: It’s interesting that you pitched the stack — when many people aren’t starting with the core insight but moving straight to products. How do you think about technology led startups vs. product led startups?

Ann Miura-Ko: I like to see some sort of key insight but it doesn’t necessarily need to be a technical innovation. For example other insights outside of tech could be:

• Supply chain advantages
• Network effects
• The ability to greatly reduce fixed costs

John Lilly: When you look at pure technology IP, I’ve met a lot of smart people who are working on really interesting research but the main problem is — what will this turn into?

Ann Miura-Ko: This is tricky because part of our thesis is to also do a few radical scientific investments. Our main risk we take is that these companies have interesting technology but is still searching for a problem.

The example I used before — Ayasdi — resonated with me because in my own research while I was a PhD, I had these complex datasets which were hard to see and understand what was inside of them. I had direct empathy for the problem Ayasdi was working on solving.

Another example we have is an investment we did in Inscopix — which originally produced a microscope you could see inside the brain of a mouse to see how it was thinking. The founder was a PhD student who was searching for how this technology could be turned into a business.

The way he solved this was the founder was very capital efficient, he raised $1.5M but sold $18M worth of devices and kept on iterating until he found the real scalable business model. VC’s struggle with this type of business — should it be big R (research) and little D (development) or little R and big D.

John Lilly: Let’s talk about marketplaces because they are a special category and you have a few investments in the space. How do you see signs that a marketplace is working? One thing we look at is to see that transactions are clearing and there is liquidity in the marketplace — how do you think about this from an early stage perspective?

Ann Miura-Ko: In the early stages of marketplaces, we typically think more about the supply side than the demand side of the marketplace. How effective are you at convincing the supply side to join your marketplace and stick with you over a long time period?

Often time a strong supply side will lead to the demand side — if supply is there and won’t leave you then demand will come.

For example with Lyft if you turn on the app and there aren’t any cars around, you are very unlikely to use the app again. With TaskRabbit if you have a lot of people bidding on your job — on the demand side, it looks like you have a robust community.

We like to see the supply side first and we have seen this to be a leading indicator to marketplace liquidity. Over time, balancing out the supply and demand is much easier if you have figured out the supply side.

John Lilly: Going back to talking about the founders, what do you like to see in early founding teams? How about solo founders?

Ann Miura-Ko: We have invested in solo founders but the healthier dynamic is to have 2–3 co-founders. Being a solo founder is lonely and you are a prisoner to your own startup — that kind of dynamic can be really bad.

Having 2–3 team members you feel much more social pressure to stay in the game and can focus the whole team on a problem, in general, teamwork is a more healthy dynamic.

The other problem is there is no superhuman founder, everyone has their own weaknesses. It’s better to round out the edges of your personally weak spots.

Even within our own firm Floodgate, there is two of us and there are some big differences between us — he’s male / I’m female — he’s white / I’m asian — he’s from Texas / I’m from Palo Alto — He is a lover / I am more of a fighter.

If I get really mad about something and he doesn’t think it’s a big deal, he can help balance me out. It’s good to have different roles from different types of people.

John Lilly: There is a debate that it’s better to have diversity early in a startup team to have diverse opinions vs. it’s better to have homogeneity so you can move fast — what do you think?

Ann Miura-Ko: I think as an early team everyone needs to have agreement on the vision. If the early team is arguing about everything in the beginning — it’s not going to work. People need to move forward in one direction together.

At the same time I think diversity in terms of perspective is valuable from the beginning. I think it’s hard to go from a homogeneous team to a diverse organization later on.

John Lilly: Personally I disagree with that and I think it is possible to scale diversity over time. Moving on to hiring — when you invest in early teams do you help them hire?

Ann Miura-Ko: It depends on the company, some will come to us for help with hiring.

However if the company is asking us for candidates, this is problematic. We have seen the best people are all finding people internally in the early stages. The best ones use their employee base to unlock talent that is not even thinking about leaving for a new job, to join their company.

If a company is advertising and posting job postings everywhere — this is a sign the company isn’t doing so well. There isn’t anyone who will advocate for your company like the people who are working there already.

We try to help our companies move in this direction vs. finding recruitings and using job boards. Those are tactics to augment in hiring but the best people are found through internal referrals.

John Lilly: Let’s talk about Lyft. They had a famous pivot moving from carpooling to an on-demand service. What many people don’t remember is they did this before Uber, UberX was a copy of Lyft. How did Lyft know it was time to pivot?

Ann Miura-Ko: While the founders were building Zimride they were constantly experimenting because they knew they didn’t have product market fit.

Zimride was originally a platform for carpooling and they sold this platform to individual Universities and companies. They were making sales but it wasn’t working as a scalable business model. They had customers but it never felt like product market fit.

Lyft was just another experiment that the team tried. They were also looking at doing bus routes from SF to Tahoe, renting vans from SF to LA, etc. The thesis for Lyft was — mobile is big and doing ride sharing peer-to-peer (P2P) would be interesting.

The big questions for Lyft before they launched was how big of an idea was this and how confident were they in trying this. Normally the founders had been very nice but when they pitched the idea of Lyft they were very intense about it and the board said to go for it and try it.

During the first week of Lyft launching (Zimride was still going on) Tommy Leep who worked with us at Floodgate said — “You have no idea how big this is going to be.” He experienced this magical moment while using Lyft and became one of their early power users.

Now the founders had this dilemma where Lyft was taking off but they still had Zimride going on at the same time. We went for a walk and they asked — what should we do with this other asset we have — should we move people over to Lyft? At the time this was a really difficult decision to make but we decided to move everyone onto Lyft.

In hindsight this is a no-brainer decision but you need to understand the founders spent 3 years of their life selling the idea for Zimride, building Zimride, raising money for Zimride, having users for Zimride, and sacrificing weekends / friends / family to try to make this happen. Then you are faced with the realization that what you have been building this whole time isn’t working, but this thing you spent a month on is working.

It takes a lot of courage to shut the thing down you have spent all of this time and energy on. I appreciate the courage it took for the founders to move aggressively into Lyft.

Nowadays people talk about pivoting as changing the homepage on your website and calling that a pivot. That’s not a pivot. A pivot is when you feel sick and you are going to throw up because what you are working on is such a dramatic shift and you don’t know if it will work or not.

Question from audience — how did the Zimride/Lyft team maintain faith while changing directions so much?

Ann Miura-Ko: The entire team was brought into trying multiple experiments from the very beginning. At the time, Lyft was just another experiment for them.

The biggest change on the team was the sales people who were selling the Zimride platform. When they shut it down these individuals had to move over to operating the marketplace and help find as many drivers as they could.

All of this is much easier once you have product market fit. It was very clear from the beginning of Lyft that it was working. In the early days the demand was so great they needed as many drivers as possible. In fact we even found people on TaskRabbit who were driving as part of their tasks and used them as Lyft drivers.
Question from audience — What do you think about Uber and the competitive pressure of Lyft vs. Uber today?

Ann Miura-Ko: I think about companies being different, not better. There were many other competitors which did P2P ride sharing but Lyft maintained an advantage because they were different.

Some of the key differences in the early days was the Lyft culture — they had the pink mustaches, the fist bump ritual, etc. They weren’t trying to be “everyone’s favorite private driver” but rather create a different type of experience.

Lyft also always had this strong community element in their product and company, this is why Lyft line works so well. This experience always translates generationally as well.

My dad used Lyft line and thought it was an incredible experience. He pushed a button and:

• the nicest man shows up
• in a beautiful car
• to take to me the hospital
• asks him about his life, how he was doing, how his day was

My dad had never had an experience like this before. If someone who is 76 can feel the difference, it will be a very defensible business.

Question from audience — When you are investing in founders, are you investing in their knowledge about market or that they are quick learners?

Ann Miura-Ko: Ideally we would want both, and we do have the patience to wait until we find a founder with both of these qualities. However if we had to pick one we would weight more towards a quick learner who is good at running many experiments.

John Lilly: Now the market for startups is very efficient. With many of my investments the decision isn’t obvious — I go from falling in love with the startup, to out of love with the startup, to back in love with it. At the end of the day you have to make a call and it's nerve racking from our side too.

Ann Miura-Ko: Most of the investments are controversial. There are so many great people working on similar things — there needs to be something special about the founders.

I have noticed that the best investments is when the partners disagree. Specifically when Mike and I disagree strongly about a particular investment, these are the ones I pay attention to.

John Lilly: I agree some of our best investments — Airbnb and Facebook — were very contentious with the partnership. Now they seem obvious in hindsight.

Question from audience— What do you think about companies which have great product market fit in Silicon Valley but might not translate to a global audience?

Ann Miura-Ko: If it’s very local to only working in Silicon Valley — we get worried. We prefer businesses that will work outside of here, especially ones that work outside of the major tech hubs.

In terms of international vs. the U.S. we think if a company can claim the U.S. market they will have a substantial business already.

Our next class is going to be covering the next level of scale. I’ll post the fifth lecture notes here.