Tech CEO Deathly Hallows: Product, Unit Economics, & Capital Allocation

Rest in Peace Alan Rickman

If you’re not familiar with the Harry Potter series, the Deathly Hallows are three powerful magical objects that were created by Death and the possessor of all three objects was the Master of Death.

What does this have to do with being a Tech CEO?

I think the markets have their own Deathly Hallows for tech CEOs and those who possess them are a Master of Markets. I was inspired to write this post partly due to a tweet by Danielle Morrill.

[embed]https://twitter.com/DanielleMorrill/status/687101715892445184[/embed]

My first reaction was to highlight there are a lot of CEOs who probably shouldn’t be CEOs:

[embed]https://twitter.com/NonGAAP/status/687137515740921857[/embed]

But upon further reflection, I realized that there are traits that make Public CEOs incredible stewards of their company in volatile markets and (largely) untouchable.

[embed]https://twitter.com/NonGAAP/status/687143218866077696[/embed]

Tech CEO Deathly Hallows

I believe there are 3 skills tech CEOs should strive to master: Product, Unit Economics, and Capital Allocation. A competent public CEO should master at least one, industry stars master two, and true generational titans have mastered all three.

Now there are CEOs who believe they have mastered all these skills, and will conveniently blame company shortcomings on issues beyond their control (legacy assets, market volatility, etc.). I’ve looked at a lot of public technology companies over the years as an activist investor, and without a doubt these situations turn into prime activist investment situations.

Product

Knowing what the customer loves and wants is arguably the hardest and most valuable skill to possess. Product typically isn’t an issue with founder CEOs and a primary reason why some investors vigorously advocate founders run the company for as long as possible. Founders possess the talent and instinct to drive the company’s vision and product(s) forward. They’re the reason why a napkin idea is now a publicly traded company in the first place.

If the founder is not running the company, it’s not a coincidence the next best solution is having a capable CEO (who is likely a master of unit economics and/or capital allocation) running the business with heavy input/influence from the founder.

So what if the founder is not involved?

There’s a reason why public market investors say invest in companies with economic moats so deep even an idiot can run it. It’s tough to find great product CEOs so investors lean on the resilience of the business franchise as a hedge.

The challenge in tech though (vs. other industries) is the industry is so dynamic and constantly changing that having a CEO with limited product capabilities is akin to captaining the Titanic through an ocean full of icebergs. For great businesses it might take the market 5 to 10 years to figure out the CEO doesn’t see the icebergs, and by the time the ship hits one it’s too late.

Of course, a lot of money can still be made by investors before the company hits an iceberg.

Unit Economics

Unit economics is comprehensively covered online, but the important thing is — beyond knowing customer lifetime value, business models, customer acquisition costs, etc. — the CEO knows the key long-term value levers of the business and has mastered how unit economics and strategy influence those levers.

Product first CEOs who master this skill are able to turn unit economics into a weapon that drives long-term value while CEOs who don’t understand their value levers and unit economics can potentially drive a company into the ground by over — or under — optimizing unit economics. There’s a real skill in knowing when to push the pedal and when to let off the gas.

Capital Allocation

Eventually great products with great unit economics produce a boat load of cash. How that cash is redeployed and reinvested can have a material impact on valuation. I’ve already written about capital allocation and the impact it has on valuation, but essentially CEOs with poor capital allocation skills can see the value of their cash flow heavily discounted because the market assumes they are going to burn it on worthless projects or aimless acquisitions.

With that in mind, it’s important to point out that markets understand innovation requires failure and experimentation. Markets don’t arbitrarily punish companies because they are innovating. Management teams earn their punitive valuation with consistent poor decisions. Fact is the market is extremely patient for those who have earned it.

Master the Deathly Hallows and a CEO will have all the time in the world.