How to Ruin Your Company with One Bad Process

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“Real quick, whole squad on that real sh*t
0 to 100, n***a, real quick”
—Drake, "0 to 100/The Catch Up"

For the audio version of this post, click here: 

https://soundcloud.com/chr1slyons/hardthings-bhorowitz-how-to-ruin-your-company-drake-the-corner

I am a giant advocate for technical founders running their own companies, but one consistent way that technical founders deeply harm their businesses is by screwing up the budgeting process. Yes, the budgeting process. How ridiculous is that? How does it happen and why is it particularly problematic for engineers?

I'll begin by describing how I screwed it up in my company. Our sales were growing so fast that the biggest problem that we faced was that we literally could not handle all the customers that wanted to sign up for Loudcloud. To combat this and enable us to grow, I worked diligently with my team to plan all the activities that we needed to accomplish to expand our capacity and capture the market before the competition. Next, I assigned sub-goals and activities to each functional head. In conjunction with my leadership team, I made sure that each goal was measurable and supported by paired metrics as well as lagging and leading indicators. I then told the team to figure out what it would take to accomplish those goals and return with their requirements for headcount and program dollars. Finally, I made adjustments to their requests based on industry benchmarks (mostly reductions) to get to a plan that I thought made sense.

Here’s the basic process:

  1. Set goals that will enable us to grow
  2. Break the goals down so that there is clear ownership and accountability for each goal by a specific team
  3. Refine goals into measurable targets
  4. Figure out how many new people are required to hit the targets
  5. Estimate the cost of the effort
  6. Benchmark against the industry
  7. Make global optimizations
  8. Execute

Unless you are an experienced manager, you may not even see what’s wrong with this process, but it very nearly led to my company's demise. In fact, the above process is completely upside-down and should only be followed if you wish to bloat your company to the brink of bankruptcy and create a culture of chaos. 

a16zsummerschool.jpgWhen I asked my managers what they needed, I unknowingly gamified the budgeting process. The game worked as follows: The objective was for each manager to build the largest organization possible and thereby expand the importance of his function. Through the transitive property of status, he could increase his own importance as well. Now you may be thinking, "That wouldn't happen in my company. Most of my staff would never play that game." Well, that's the beauty of the game. It only takes one player to opt in, because once someone starts playing, everybody is going in -- and they are going in hard. 

Gameplay quickly becomes sophisticated as managers develop clever strategies and tactics to improve their chances for winning. One common game technique is to dramatically expand the scope of the goals: "When you said that you wanted to increase our market presence, I naturally assumed that you meant globally. Surely, you wouldn’t want me to take a U.S.-centric view." To really motivate the CEO, another great technique involves claiming dire circumstances if the company fails to achieve its metrics: "If we don't increase sales by 500% and our top competitor does, we will fall behind. If we fall behind, we will no longer be No. 1. If we’re not No. 1, then we won’t be able to hire the best people, command the best prices, or build the best product, and we will spin into a death spiral." Never mind the fact that there is almost no chance that your competitor will grow 500% this year. 

Another subtle problem with this process is that when I asked my team what they needed to achieve their goals, they naturally assumed they would get it. As a result, my team deeply socialized their ideas and newly found money with their teams. This has the added gaming benefit of inextricably tying their demands to company morale. When the VP of marketing asked me for 10 headcount and $5M in program expenses, then shared that plan with his team, it changed the conversation. Now a major cutback to his plan would alarm his team because they had just spent two weeks planning for a much more positive scenario. “Wow, Ben greatly reduced the plan. Should I be looking for a job?” This kind of dynamic put pressure on me to create a more expansive expense plan than was wise. Multiply this by all my managers and I was on my way to burning up all my cash and destroying my culture. 

My core problem was that my budgeting process did not have any real constraints. We were private and did not have a specific profit target that we needed to hit and we had plenty of cash in the bank. Drawing the line on expenses seemed rather arbitrary. In the absence of a hard constraint, I had no constraint. 

An excellent constraining principle when planning your budget is the preservation of cultural cohesion. The enemy of cultural cohesion is super-fast headcount growth. Companies that grow faster than doubling their headcount annually tend to have serious cultural drift, even if they do a great job of onboarding new employees and training them. Sometimes this kind of growth is necessary and manageable in certain functions like sales, but is usually counterproductive in other areas where internal communication is critical like engineering and marketing. If you quadruple your engineering headcount in a year, you will likely have less absolute throughput than if you doubled headcount. As an added bonus, you will burn way more cash. Even worse, you will lose cultural consistency as new people with little guidance will come in with their own way of doing things that doesn’t match your way of doing things. Note that this does not apply to you if you have very small numbers. It's fine to grow engineering from one to four people or from two to eight. However, if you try to grow from 50 to 200, you will cause major issues if you are not extremely careful.

Starting with the cultural cohesion principle, a far better way to run the budgeting process is to start with the constraints. Some useful constraints are:

  • Run rate increase – Note that I say "run rate increase" and not "spend increase". You should set a limit on the amount by which you are willing to increase what you are spending in the last month of the coming year vs. the previous year. 
  • Earnings/Loss – If you have revenue, another great constraint is your targeted earnings or loss for the year. 
  • Engineering growth rate – Unless you are making an acquisition and running it separately or sub-dividing engineering in some novel way, you should strive not to more than double a monolithic engineering organization in a 12-month period.
  • Ratio of engineering to other functions – Once you have constrained engineering, then you can set ratios between engineering and other functions to constrain them as well. 

 After applying the global constraints, the following steps will provide a better process:

  1. Take the constrained number that you created and reduce it by 10-25% to give yourself room for expansion, if necessary.
  2. Divide the budget created above in the ratios that you believe are appropriate across the team.
  3. Communicate the budgets to the team.
  4. Run your goal-setting exercise and encourage your managers to demonstrate their skill by achieving great things within their budgets.
  5. If you believe that more can legitimately be achieved in a group with more money, then allocate that manager extra budget out of the slush fund you created with the 10-25%.

At this point, some readers may think that I've lost my mind. As a technologist, you know that the worst thing that you can do is over-constrain the problem before you start. You'll kill creativity and prevent yourself from getting a truly great outcome. That's precisely why I, as an engineer, struggled with this process: the human factors muck up the logic. Specifically, local incentives, if not properly managed, will sharply motivate human behavior and defeat the global goals. 

It’s critical to recognize this so that you don’t turn your agile, small company into a slow, big company before its time.

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Do You Feel Pressure or Do You Apply Pressure?

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"To whoever think their words affect me is too stupid
And if you can do it better than me, then you do it"
—Kanye West, "Cold"

One obvious yet under-appreciated law of business physics is: For any given company, the larger the company becomes, the more opportunities emerge to screw it up. 

Another obvious, but not well understood law: The more screwed up your company, the more people will complain about it and blame you.

If we take these two together, it is easy to see that without intervention the larger your company becomes, the more people will complain and blame you. 

This seems simple enough, but CEOs often fail to understand the logic, become overwhelmed by the criticism, lose confidence in themselves, and decide that they are no longer capable of running their own companies. This can be tragic as I explained in “Why We Prefer Founding CEOs”

If you are a logical and open-minded person, it is difficult not to take a 10X increase in criticism seriously. More importantly, it's difficult not to take a 10X increase in criticism personally. So how can a CEO keep from getting ground into sawdust by complaints from her own people? The answer comes from a simple CEO aphorism: You either apply pressure or you feel pressure

Let's begin by looking at the overwhelming spiral. As your company grows, people start complaining about everything from your sales efforts being underwhelming to there not being enough organic snacks in your free food section. In the meanwhile, you are trying to wrestle serious product strategy questions posed by scary competitors to the ground. You don't know the answers to most of the complaints, so you defer them and focus on what you know. The problems related to the complaints fester and grow. Your employees get frustrated that the issues are not being fixed and complain louder. They begin to lose confidence in you as CEO.

The Best Defense is a Good Offense

The key to breaking the cycle is to stop feeling pressure and to start applying it. The most basic way to do this is to assign the problems to your team. This transfers the pressure from you to the organization and has the added benefit of empowering the team. 

At this point, those of you who have read my book are thinking: "Ben, that's not the hard thing about this. The hard thing isn't delegating, the hard thing is when the executive disagrees that there's a problem or there is no logical owner or the problem is cross-functional or the executive tries to give it back to you." Let's take these in order. 

The executive fundamentally disagrees that there is a problem
Imagine that your employees are complaining about the number of bugs in your product and you ask your head of engineering to improve quality. Chances are that he will not say: "Sure thing, boss." He will much more likely say: "By what definition?" He will likely have way more data than you about product quality and it will be difficult for you to win the argument. Yet you know the employees are right, which is why you didn't explain to them they were wrong in the first place. 

The reason for the stalemate is that quality in the abstract is an intractable problem. In fact, most problems in the abstract have this property. If you want it fixed, you must be specific. Doing so is tricky in this case because no software organization has ever produced bug-free software in every version. So if you don't want zero, then how many bugs are too many? The best way to start is to frame it in terms of something that you know well. Sometimes this will mean moving to a more qualitative argument. For example, pick your 3 favorite bugs and use them as examples. Describe why they are particularly damaging and try to classify them as best you can. Let your executive know that bugs like that should not ship and if they do accidentally ship then the company should not rest until they are fixed. Then ask him to do something specific: have him tell you exactly how many bugs are outstanding in the classes that you identified and report back on when they will be fixed. Then ask him to make a proposal about how he will systematically do a better job on this in the future. Finally, let him know what you are willing to give up in terms of other work (schedule, features, etc.) to make this a priority. Getting specific will help energize the team as it will give them a problem they can actually solve. It will also clearly communicate that you are super serious about the issue. 

The problem is cross-functional
Imagine that your sales people keep complaining that there aren't enough leads. You feel as though they are Jack Lemmon in Glengary Glen Ross. But then you go to your head of marketing and he demonstrates that he's generated 150% of the leads that he was supposed to generate based on his objectives. What do you do? There are many possible issues: the definition of a lead differs, the profile of the target customer differs, somebody is lying, etc. As tempting as these possible solutions may be, resist the temptation to solve this one yourself. Instead, get both executives together and let them know that you need them to agree on a common definition of a lead, a method for determining whether any given lead meets the description and an objective for the head of marketing to hit next quarter that both he and the head of sales will be happy with. Give them a firm deadline and let them know that you will take no excuses, because you have a whole field filled with demotivated sales reps and you will not stand for that. Apply pressure. 

There is no logical owner
Sometimes a problem has no owner. Customer churn has increased in the past 2 quarters. It's an important issue and left unchecked it could become mission critical. However, it's not the top priority in the company today. To further create CEO procrastination, it's not clear whether it's a customer support problem, a sales problem, a services problem, a product quality problem or some combination of all four. In reality, it's probably a CEO problem, but if it's not the top priority in the company, having the CEO personally drive it to resolution may not be the best idea. So, what do you do? You assign the problem to an illogical owner. In this case, you might assign it to the head of sales, because she has the highest incentive to fix it properly—otherwise she has to resell all those deals to make quota. You empower her to dig into each churned account, find the root cause analysis, and report back to the team on a frequent basis. Once the root cause has been determined, she should propose a cross-functional plan to fix the problem. 

This is an imperfect strategy in many ways. The problem might be entirely with sales setting poor expectations and she might cover that up. The various groups might not get along well and not want to listen to a peer. The head of sales might not have a great idea of what's possible in engineering or customer support. Imperfect yes, but far better than doing nothing, which is generally what happens when the CEO has too much on her plate and doesn't apply pressure. 

The assigned executive tries to give it back
Your company's engineering schedules are unpredictable and your engineering throughput is poor, so you ask your VP of engineering to fix the problem. She complains: "The schedule keeps slipping because the product management team keeps changing the priorities and thrashing the engineers back and forth across the various projects." You say: "Great. I will work with product management to get them to cut that out." The VP of product management replies: "I'd love to stop with the requirements, but we need certain things to close large deals and make the quarterly number." You then go to the head of sales and she says: "Do you want me to make my number or not?"

In this case, everyone is under empowered to make the right decision and get you what you want. The key to delegation is better empowerment. You could simply give the head of engineering the ability to say "no" to everything, but you may well miss all your sales forecasts and cause yourself an even bigger problem. A better approach would be to formalize the change process. You can say that once a project begins, you can alter its definition, resources, priorities, or schedule, but doing so requires a formal meeting with all the stakeholders and the CEO. At that meeting, all changes and their potential consequences will be discussed and a decision will be reached. If you implement such a process, you will find that the number of changes drops by an order of magnitude. By simply making it more difficult to make a change, you will apply pressure to the team to find another way to make the sales number. 

At this point, you haven't empowered the head of engineering to control her own destiny, but you have empowered the team to give you what you want.

Using Pressure to Evaluate Executives

Founding CEOs often find it difficult to evaluate executives. How do I know if my head of marketing is world class? I've never run marketing. Applying lots of pressure is a great way to sharpen your instincts when evaluating executives.

If you consistently apply pressure to an executive and get no results, then you very likely need to upgrade that position. The whole point of paying an executive all that money and giving her that fat stock option package is to take the pressure off of you and give you some leverage. If she can't do that, then she must go. She may be a fine executive for another CEO, but not for you. 

On the other hand, when you have a problem that you have no idea how to solve and you delegate it to an executive and she solves it, then she's extremely valuable. 

Final Thoughts

If you are feeling overwhelmed and under competent, then you are very likely not applying enough pressure.

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From Rap Genius to Genius

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"They call me Jay Electronica – f*ck that
Call me Jay ElecHanukkah, Jay ElecYarmulke
Jay ElecRamadaan, Muhammad A'salaamaleikum
RasoulAllah Subhanahu wa ta'ala through your monitor"
—Jay Electronica, "Exhibit C"

When we first invested in Rap Genius, many people asked us why a Silicon Valley venture capital firm would invest in a website about rap music. We patiently explained that Rap Genius was not just about rap, but was a platform for capturing the knowledge about the knowledge for rap and everything else. I then pointed to important examples in literature, poetry, law, and current events

Given the broad and important ambition of the company, starting with rap was ideal. This was not intuitive to most. As I have come to understand, for many rap music is either trivial or indecipherable, and “too ethnic.” In reality, rap artists delivered the greatest poetry of the past 30+ years and have given meaning, inspiration, and hope to people across ethnicities.

Why this difference between perception and reality? Because understanding rap requires deep context. To fully appreciate it, you need knowledge of the culture, knowledge of the history, and knowledge of the people. In other words, rap is the perfect category for a platform that aims to provide the knowledge about the knowledge. Rap Genius has, in fact, become the essential knowledge source for understanding rap music. 

In doing so, the team at Rap Genius developed two essential assets. First, they created a technology platform that systematically enables a group of scholars to converge on the most correct explanation of a piece of text or video. Next, because people with an interest in rap music tend to be on the cutting edge of culture, Rap Genius fostered a community of cultural experts who have already branched out into important adjacent knowledge areas such as poetry and rock and roll.

Based on these two pillars, today Rap Genius officially expands beyond rap and renames itself Genius. Genius does for everything what Rap Genius did for rap. As part of that, the company is also announcing a new $40M round of funding lead by Dan Gilbert. Rap Genius will continue, forever, as part of the Genius family. I have looked forward to this day for quite some time and welcome everyone to Genius, the explanation of everything.

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The Legend of The Blind MC

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People say I’m crippled, but that’s a lie
they’re just mad ‘cause I’m so fly
being handicapped is a state of mind
I’m not disabled I’m just blind
—The Blind MC

People often ask me how Hip Hop became the inspiration for all my thinking on leadership and why I feature it so much in my blog posts. In the past, I have given short and incomplete answers, but here is the full story. It probably belongs in The Hard Thing About Hard Things, but I did not know how to tell it without Rap Genius.

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Why I Will Give 100% of My Book Earnings to Women in the Struggle

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There is a woman in Somalia
Scraping for pearls on the roadside
There's a force stronger than nature
Keeps her will alive
This is how she's dying
She's dying to survive
Don't know what she's made of
I would like to be that brave.
—Sade, “Pearls”

Never believe that a few caring people can't change the world. For, indeed, that's all who ever have.
—Margaret Mead

I will donate all of my proceeds from The Hard Thing About Hard Things to American Jewish World Service to support their efforts to help women fight for their basic rights throughout the world. 

Since there are many important causes, I thought that it would be worth explaining why I am supporting this one.

When I was 11 years old, I was exposed to chronic cruelty on a global scale. I watched the miniseries “Roots” based on Alex Haley's bestselling novel about slavery in the United States. I was riveted and horrified. It was my first real introduction to slavery and I could not believe what I was seeing. I saw families broken apart as they were sold to different owners. I saw slaves pleading for their lives only to be brutalized and killed. How could anybody be so cruel? How could everybody sit by and watch it happen? How was this even possible? I could not have been more shocked.

I was deeply disturbed by the whole experience and sought to find out how it happened. I studied humankind's long history with slavery. I learned that in the 1600s, 75% of the world's population was enslaved. I learned that the Caribbean form of the African slave trade was far more brutal than the U.S. version. I studied the complex economics of slavery and why it was difficult to unwind once started. I began to wonder how slavery ever ended.

Then I began to study the abolitionists. Men like former slave ship captain John Newton who later wrote the song “Amazing Grace”. People like the great Thomas Clarkson who at times seemed to be alone in taking on the world. I learned how a few unimaginably brave people took on the entire globe and its brutal institution. They did not care about the twisted history or corrupt cultures that created slavery. They just wanted it stopped. Clarkson took great personal risk in traveling by boat back and forth across the Atlantic to record and tell the story of slavery for no reason other than he wanted it ended. He dedicated his life to stopping the cruelty. His story is among the most inspirational in human history.

It had to be, because the most incredible thing about slavery was how it ended. An institution that was embedded into human culture, endorsed by the Bible, promoted by the Qur’an, pervasive in society, and embedded in the global economy was taken on and defeated by a movement started by a tiny number of people. These brave souls had no Twitter or Facebook. They had no Internet or telephones or automobiles, but they organized people across the world and largely stopped slavery globally. 

After understanding how slavery ended, I promised myself that if something like that ever happened in my time, I would be part of the group who tried to stop it.

Sadly, something like slavery is happening in my time. It's not happening in the United States, but it is happening and the victims are women. In many parts of the world, women are literally owned by men. Women do not enjoy basic rights, are denied access to education, can be arbitrarily raped, robbed, and killed, and live in fear with no chance for self-determination. A few revealing statistics:

  • Every year 10 million girls under the age 18 enter into early and forced marriages
  • 2 million girls a year undergo genital cutting
  • Two-thirds of the world's illiterate adults are women
  • Women constitute about 70% of the world’s absolute poor (i.e., those living on less than a dollar a day) 

Meanwhile, the rhetoric deployed in resistance to women's rights is eerily reminiscent of resistance to freeing slaves. Consider this statement from the Muslim Brotherhood in resistance to a U.N. declaration calling for an end to violence against women:

This declaration, if ratified, would lead to complete disintegration of society, and would certainly be the final step in the intellectual and cultural invasion of Muslim countries, eliminating the moral specificity that helps preserve cohesion of Islamic societies.[1]

And compare it to this poem written in defense of slavery in England in 1789:

If our slave trade had gone, there's an end to our lives
Beggars all we must be, our children and wives
No ships from our ports, their proud sails e'er would spread,
And our streets grown with grass where the cows might be fed.[2]

Like Thomas Clarkson and the abolitionists, Ruth Messinger and AJWS are starting at the grass roots level, but are already making great progress.

Consider Rehana Adib. At age 12, she was raped by a group of older relatives. She bravely told her father, but he responded by arranging for her to marry a middle-aged man—a match designed to protect her security and reputation. Like many other girls her age, she was forced to drop out of school and was expected to be a subservient wife and mother. She was not free to make choices about her daily life and her own future.

But Rehana refused to be silent. She found a women’s organization in her neighborhood and began to learn about her rights. She took workshops in leadership and activism and gained the courage to speak out about her experiences. By the time Rehana was 18, she was an active member of the local women’s movement and was already helping other girls overcome the challenges they faced. Although her family and community criticized her work at first, she slowly gained their respect and is now looked to as a leader in her community. 

In 2005, Rehana founded her own organization, Astitva, in Muzzafarnagar—a rural area in Uttar Pradesh, India. With AJWS’s support, Astitva works today to stop both sexual violence and child marriage, helping give girls a chance at a brighter future.

The systematic cultural abuse of women worldwide must end. Let’s end it.  



[1] http://www.theguardian.com/world/2013/mar/15/muslim-brotherhood-backlash-un-womens-rights

[2] Bury the Chains, page 185

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Why I Did Not Go To Jail

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A lot of people have been asking me what my upcoming book, The Hard Thing About Hard Things, will be like. Here's a piece that I wrote for the book that did not make the cut. I still think it's a pretty good story and gives you a flavor.

I just tell the truth so I'm cool in every hood spot
21 years and I ain't ever met a good cop
—Drake, “I’m Goin In”

After we transitioned the business from Loudcloud to Opsware, we needed a head of finance. Therefore, when the CFO from one of the best-run enterprise software companies became available, I jumped at the chance to hire her.

Michelle (note: her name has been changed) comprehensively understood software accounting, business models, and best practices, and she was beloved by Wall Street in no small part due to her honest and straightforward reporting of her previous company’s business. In my reference checking, at least a dozen investors told me that they made far more money when the numbers disappointed than when the company outperformed, because they trusted Michelle when she said that things were not worse than they appeared and bought on the dips.

Once she came on board, Michelle rapidly reviewed all of our practices and processes to make sure we were both compliant and competitive. One area where she thought we were less than competitive was our stock option granting process. She reported that her previous company’s practice of setting the stock option price at the low during the month it was granted yielded a far more favorable result for employees than ours. She also said that since it had been designed by the company’s outside legal counsel and approved by their auditors, it was fully compliant with the law. 

It all sounded great: better incentives for employees at no additional cost or risk. However, after nearly four years of disastrous surprises, nothing made me more nervous than things that sounded great. On top of that, changes related to accounting law always worried me.

They worried me, because every incentive that we put in place as a company was designed to encourage people to achieve their goals. All these incentives had the caveat that the goals must be achieved while obeying the law. Now that may sound simple, but in virtually every meeting every day people discuss their goals and how they will achieve them. They almost never discuss accounting law. In a sales forecast meeting, you will often hear, “What can we do to get this closed by the end of the quarter?” You never hear, “Will the way we made the commitment comply with Statement of Position-97-2 (the critical software accounting rule)?”

Beyond that, U.S. accounting law is extremely difficult to understand and often seems illogical and random. For example, the law in question with respect to stock options, FAS 123, is filled with paragraphs such as this:

“This Statement does not specify the measurement date for share-based payment transactions with nonemployees for which the measure of the cost of goods acquired or services received is based on the fair value of the equity instruments issued. EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, establishes criteria for determining the measurement date for equity instruments issued in share-based payment transactions with nonemployees.”

And that is the clear part.

To guard against employees purposely or accidentally breaking the law in pursuit of their goals, I took two broad measures. First, when we started the company, Marc and I agreed that the company’s General Counsel would always report directly to me. This is different than in many technology companies where the General Counsel reports to the Chief Financial Officer. That way, there would be no way for another executive to subvert the law in pursuit of the number. Secondly, I would regularly give a speech to the finance employees that went like this: 

“In this business, we may run into trouble. We may miss a quarter. We may even go bankrupt, but we will not go to jail. So if somebody asks you to do something that you think might put you in jail, call me.”

With that as a backdrop, I told Michelle that a better stock granting process sounded great, but I needed Jordan Breslow, my General Counsel, to review it before making a decision. Jordan lived in my hometown of Berkeley and he certainly belonged there. With hippie sensibilities, Jordan was nearly allergic to corporate politics, showmanship, or any behavior that covered the truth. As a result, I knew that what he said was 100% what he believed and had nothing to do with anything else. I could trust it. Michelle was surprised, as her previous company had run this practice for years with full approval from PricewaterhouseCoopers, its accounting firm. I said: “That’s all fine and good, but I still need Jordan to review it first.”

Jordan came back with an answer that I did not expect: “Ben, I’ve gone over the law six times and there’s no way that this practice is strictly within the bounds of the law. I’m not sure how PwC justified it, but I recommend against it.” I told Michelle that we were not going to implement the policy and that was that. 

Well, that was that for a while. Then, almost two years later, the SEC announced that it was investigating Michelle’s previous company for stock option accounting irregularities. This started a massive investigation of all Silicon Valley companies and their stock option accounting practices. All told, more than 200 companies were found guilty of some sort of irregularity.

In November of 2005, Michelle’s previous employer announced that it was removing most of its management team in an admission of wrongdoing. The SEC issued Michelle a Wells notice, a letter stating that it planned to recommend enforcement action against her personally. It was not an indictment, but it was a formal investigation, and it would be very distracting. I had to ask her to step down. In some ways the choice was obvious—we could not put the entire company at risk for one person. Still, firing somebody who had done nothing wrong at Opsware was tough. Nonetheless, Michelle graciously resigned as she did not want to bring negative attention to the company.

In the days that followed, I carefully positioned the change to both protect the company and not put Michelle in a bad light. I told our employees that there was a difference between accounting fraud and accounting mistakes and I believed that Michelle made mistakes at her previous company, but did not commit fraud. I explained to our investors who loved Michelle that I also thought very highly of her, but I had no choice. The company came first.

Michelle ultimately served 3½ months in jail for her part in the other company’s stock option practice—the same practice that we nearly implemented at Opsware. Since we had the same head of finance, we almost certainly would have been investigated. I obviously don’t know what happened at the other company, but I do know that Michelle had no intention of breaking any laws and no idea that she’d broken any laws. The whole thing was a case of the old saying: “When the paddy wagon pulls up to the house of ill repute, it doesn’t matter what you are doing. Everybody goes to jail.” Once the SEC decided that most technology company stock option procedures were not as desired, the jail sentences were handed out arbitrarily. 

In retrospect, the only thing that kept me out of jail was some good luck and an outstanding General Counsel, and the right organizational design.

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Estonia: The Little Country That Cloud

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Co-authored with Sten Tamkivi, EIR at Andreessen Horowitz

Follow the leader is a title, theme, task
Now you know, you don't have to ask
—Rakim, "Follow the Leader"

Being someone reasonably well-known in technology, I have been getting a lot of questions lately about Healthcare.gov. People want to know why it cost between 2 and 4 times as much money to create a broken website than to build the original iPhone. This is an excellent question. However, in my experience, understanding why a project went wrong tends to be far less valuable than understanding why a project went right. So, rather than explaining why paying anywhere between $300M and $600M to build the first iteration of healthcare.gov was a bad idea, I would like to focus attention on a model for software-enabled government that works. In doing so, perhaps this will be a step toward a better understanding of how technology might make the US government better and not worse.

Early in my career as a venture capitalist, we invested in a company called Skype and I went on the board. One of the many interesting aspects of Skype was that it was based in Estonia, a small country with a difficult history . Over the centuries, Estonia had been invaded and taken over many times by many countries including Denmark, Sweden, Germany, and most recently the Soviet Union. Now independent, but well aware of their history, the Estonian people were humble, pragmatic, proud of their freedom, but dubious of overly optimistic forecasts. In some ways, they had the ideal culture for technology adoption: hopeful, yet appropriately skeptical.

Supported by this culture, Estonia built the technology platform to serve its citizens that everyone wishes we had here. Estonia developed an infrastructure that enabled its government to serve its people so well that Estonians would like to see more, not fewer, government technology projects. To explain how they did it, I've asked one of our Entrepreneurs in Residence and Estonian, Sten Tamkivi to tell the story.


 

At a casual glance, Estonia might not show up on the US radar too often. It is a tiny country in North Eastern Europe, just next to Finland. It has the territory of the Netherlands, but 10x less people. 1.3 million inhabitants is comparable to Hawaii. Estonia belongs to the European Union, Eurozone and NATO. In other words, as a friend from India recently quipped: "what is there to govern?"

What makes this tiny country interesting as a governance benchmark is not just that the people can elect their parliament online or get their taxes back in two days. It is rather that this level of service for citizens does not start from their government building a few web sites. Instead, Estonians started by redesigning their entire information infrastructure from the ground up with openness, privacy, security and future proofing in mind.

As the first building block of e-government, you need to be able to tell your citizens apart. Sounds blatantly obvious, but sometimes referring to a person by their social security number, then by a taxpayer number and at other times by something else doesn't cut it. Estonia uses a very simple, unique ID methodology across all systems, from your paper passport to bank records to any government office or hospital. A citizen with personal ID code 37501011234 is a male born in the 20th century (3), on January 1st of year '75, as baby #123 of that day. The number ends with a computational checksum to easily detect typos.

For these identified citizens to transact with each other, Estonia passed the Digital Signatures Act back in 2000. The state standardized on national Public-key Infrastructure (PKI), which binds citizen identities to their cryptographic keys,  and now doesn't care if any Tiit and Toivo (to use some common Estonian names) sign any contract between them in electronic form with certificates, or plain ink on paper. A signature is a signature in front of all laws.

As a quirky side-effect, that foundational law also forced all decentralized government systems to become digital "by market demand". Namely, no part of Estonian government can turn down a citizen's digitally signed request to ask for a paper copy. As citizens opt for convenience, bureaucrats see a higher inflow of digital forms and are self-motivated to invest in systems that will help them manage the process. Yet a social worker in a small village can still provide the same service with no big investment by handling the small number of digitally signed email attachments the office receives.

For future-proofing, the law did not lock in the technical nuances of digital signatures. In fact, the implementation has already been changing over time. Initially, Estonia equipped all traditional ID cards issued to every citizen for identification and domestic travel inside EU with a microchip. The chip carries two certificates: for full legal signatures and for authenticating to any trusting web site or service (used widely from government services to Internet banks). As every person over 15 is required to have one, there are now over 1.2M cards active, a close to 100% penetration of population.

As mobile adoption in Estonia rapidly approached the current 144% (#3 in Europe), the digital signatures adapted too. Instead of carrying a smartcard reader with their computer, users can now get a Mobile ID enabled SIM card from their telecom operator. Without installing any additional hardware or software, they can access systems and give signatures by just typing PIN codes on their mobile phone.

As of this writing, between ID cards and mobile phones, 1.3M Estonians have authenticated 230M times and given 140M legally binding signatures. Besides the now daily usage for commercial contracts and bank transactions, the most high profile use case has been the elections: since being the first country in the world to allow voting for local elections in 2005, the system has been used for both Estonian and European Parliament Elections and in 2011 counted for already 24% of all votes. (Interestingly, the citizens voted from 105 countries in total, where they just happened to be physically at the time - like my own vote submitted from California).

To further speed this sort of innovation, the state tendered building and securing the digital signature certificate systems to private parties, namely a consortium led by local banks and telcos. And that's not where the public-private partnerships end: the way the data interchange in the country works is that both public & private players can access the same data exchange bus (dubbed X-Road), enabling truly integrated e-services.

A prime example is the income tax declarations Estonians "fill". Quote marks are appropriate, because when an average Estonian opens the form for submission once a year, it usually looks more like a review wizard: "next -> next -> next -> submit". This is because data has been already moving throughout the year: when employers report employment taxes every month, all the data entries are already linked into a particular person's tax records too. Non-profit reported charitable donations are recorded back as deductions for the giver the same way. Tax deductions on mortgages come directly from data interchange with commercial banks. And so forth. Not only is the income tax rate in the country a flat 21%, after submitting this pre-populated form the citizens actually get any overpayment back on their bank account (digitally transferred, of course) on the second day!

This liquid movement of data between systems relies on a fundamental principle to protect the privacy of the citizens: without any question, it is always the citizen who owns their data. People have the right to control access to their data. For example, in case of fully digital health records and prescriptions, people can granularly assign access rights to the general practitioners and specialized doctors of their choosing. And in scenarios where the rule of law can't allow them to block the state from seeing their information, like with the Estonian e-policemen using their real time terminals in police cars or offices, they at least get a record of who accessed their data and when. If an honest citizen finds any official checking on their stuff without valid reason, they can file an inquiry and get them fired.

Having everything online does generate security risks on not just personal, but systematic and national level. Estonia was the target of The Cyberwar of 2007 when well coordinated botnet attacks following some political street riots targeted government, media and finance sites and effectively cut the country from the internet abroad for several hours. But as a result, Estonia has since become the home for NATO Cyber Defence Centerand EstonianPresident Toomas Hendrik Ilves has risen internationally to be one of the most vocal advocates for cybersecurity topics among the world's heads of states.

Even more interestingly, there is a flip-side to the fully digitized nature of Republic of Estonia: taken to the max, having the bureaucratic machine of a country humming in the cloud increases the cost of any potential physical assault to the state. Imagine if physical invasion of this piece of Nordic land by anyone would not stop the government operating, but booted up a backup replica of the digital state hosted in some other friendly European territory. Democratic government would be quickly re-elected, important decisions made, documents issued, business & property records maintained, births and deaths registered and even taxes flowed by those citizens still with access to the internet. May sound futuristic, but this is exactly the kind of world Estonia's energetic CIO Taavi Kotka can not just dream up but actually implement, on the e-foundations the country already has today.

Yes, the circumstances of the Estonian story are special by many means. The country emerged to re-independence from 50 unfortunate years of Soviet occupation in 1991, having skipped a lot of technological legacy the Western world had built up during '60-'80s, such as checkbooks and mainframe computers and jumped right into the mid-nineties bandwagon of TCP-IP enabled web apps. During this social reset, Estonians also decided to throw their former communist leaders overboard and elected new leadership - with ministers in their late twenties from whom one can expect disruptive thinking.

But then again, all this was 20 years ago. Estonia has by many macroeconomic and political notions become more of "a boring European state," stable and predictable, if just somewhat faster growing to close the gap with Old Europe from the time they were behind the Iron Curtain. 20 years, but you can still think of Estonia as a startup country, not just by life stage, but by mindset.

And this is what United States, along with many other countries struggling to get the internet and their increasingly more mobile citizens on it, could learn from Estonia: the mindset. Willingness to question the foundations and get the key infrastructure right, and to continuously re-invent on them. States can either build healthcare insurance brokerage sites for innovation, or really look at what key components need to exist for any service to be built: signatures, transactions, legal frameworks and such.

Ultimately, the states that create pleasant environments will be where the mobile citizens will flock to live their lives. And by many means, tiny Estonia in 2014 is no worse positioned to be the destination than New England was in 1814.

 


Further reading

 

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Can Do vs. Can’t Do Cultures

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God body and mind, food for the soul
When you feeding on hate, you empty, my ni*&$a, it shows”
—Rick Ross, “Hold On”

The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore, all progress depends on the unreasonable man.
-George Bernard Shaw

Lately, it’s become in vogue to write articles, comments and tweets about everything that’s wrong with young technology companies. Hardly a day goes by where I don’t find something in my Twitter feed crowing about how a startup that’s hit a bump in the road is “fu&%@d” or what an as*h%le a successful founder is or what an utterly idiotic idea somebody’s company is. It seems like there is a movement to replace today’s startup culture of hope and curiosity with one of smug superiority.

Why does this matter? Why should we care that the tone is tilting in the wrong direction? Why is it more important to find out what’s right about somebody’s company than what’s wrong? 

The word technology means “a better way of doing things.” This is easy to say, but extremely difficult to do. Making a better way of storing information, a better currency, or a better way of making friends means improving on thousands of years of human experience and is therefore extraordinarily difficult. At some level, it would seem logically impossible that anybody could ever improve anything. I mean if nobody from bible days until 2014 has thought of it, what makes you think you are so smart? From a psychological standpoint, in order to achieve a great breakthrough, you must be able to suspend disbelief indefinitely. The technology startup world is where brilliant people come to imagine the impossible.

As a Venture Capitalist, people often ask me why big companies have trouble innovating while small companies seem to be able to do it so easily. My answer is generally unexpected. Big companies have plenty of great ideas, but they do not innovate because they need a whole hierarchy of people to agree that a new idea is good in order to pursue it. If one smart person figures out something wrong with an idea–often to show off or to consolidate power–that’s usually enough to kill it. This leads to a Can’t Do Culture.

The trouble with innovation is that truly innovative ideas often look like bad ideas at the time. That’s why they are innovative – until now, nobody ever figured out that they were good ideas. Creative big companies like Amazon and Google tend to be run by their innovators. Larry Page will unilaterally fund a good idea that looks like a bad idea and dismiss the reasons why it can’t be done. In this way, he creates a Can Do Culture.

Some people would like to turn the technology startup world into one great big company with a degenerative Can’t Do Culture. This post attempts to answer that challenge and reverse that tragic trend.

Dismissive rhetoric with respect to technology is hardly new. Sometimes the criticism is valid in that the company or invention does not work, but even then it often misses the larger point. Here are two historical examples to help illustrate: 

The Computer

In 1837, Charles Babbage set out to build something he called The Analytical Engine the world’s first general-purpose computer that could be described in modern times as Turing-complete. In other words, given enough resources the machine that Babbage was building could compute anything that the most powerful computer in the world today can compute. The computation might be slower and the computer might take up more space (OK, amazingly slow and incredibly huge), but his design matched today’s computational power.  Babbage did not succeed in building a working version as it was an amazingly ambitious task to build a computer in 1837 made out of wood and powered by steam. Ultimately, in 1842 English mathematician and astronomer George Biddel Airy advised the British Treasury that the Analytical Engine was “useless” and that Babbage’s project should be abandoned. The Government axed the project shortly after. It took the world until 1941 to catch up with Babbage’s original idea after it was killed by skeptics and forgotten by all.

171 years later, it’s easy to see that his vision was true and computers would not be useless. The most important thing about Babbage’s life was not that his timing was off by 100 years, but that he had a great vision and the determination to pursue it. He remains a wonderful inspiration to many of us to this day. Meanwhile, George Biddel Airy seems more like a short-sighted crank.

The Telephone

Alexander Graham Bell, inventor of the telephone, offered to sell his invention and patents to Western Union, the leading telegraph provider, for $100,000. Western Union refused based on a report from their internal committee. Here are some of the excerpts of that report: 

“The Telephone purports to transmit the speaking voice over telegraph wires. We found that the voice is very weak and indistinct, and grows even weaker when long wires are used between the transmitter and receiver. Technically, we do not see that this device will be ever capable of sending recognizable speech over a distance of several miles. 

“Messer Hubbard and Bell want to install one of their “telephone devices” in every city. The idea is idiotic on the face of it. Furthermore, why would any person want to use this ungainly and impractical device when he can send a messenger to the telegraph office and have a clear written message sent to any large city in the United States?

“The electricians of our company have developed all the significant improvements in the telegraph art to date, and we see no reason why a group of outsiders, with extravagant and impractical ideas, should be entertained, when they have not the slightest idea of the true problems involved. Mr. G.G. Hubbard’s fanciful predictions, while they sound rosy, are based on wild-eyed imagination and lack of understanding of the technical and economic facts of the situation, and a posture of ignoring the obvious limitations of his device, which is hardly more than a toy… .

“In view of these facts, we feel that Mr. G.G. Hubbard’s request for $100,000 of the sale of this patent is utterly unreasonable, since this device is inherently of no use to us. We do not recommend its purchase.”

The Internet

Today most of us accept that the Internet is important, but this is a recent phenomenon. As late as 1995, Astronomer Clifford Stoll wrote the article entitled Why the Web Won’t Be Nirvana in Newsweek, which includes this unfortunate analysis: 

Then there’s cyberbusiness. We’re promised instant catalog shopping—just point and click for great deals. We’ll order airline tickets over the network, make restaurant reservations and negotiate sales contracts. Stores will become obselete. So how come my local mall does more business in an afternoon than the entire Internet handles in a month? Even if there were a trustworthy way to send money over the Internet—which there isn’t—the network is missing a most essential ingredient of capitalism: salespeople.

What mistake did all these very smart men make in common? They focused on what the technology could not do at the time rather than what it could do and might be able to do in the future. This is the most common mistake that naysayers make.

Who does the Can’t Do Culture hurt the most? Ironically, it hurts the haters. The people who focus on what’s wrong with an idea or a company will be the ones too fearful to try something that other people find stupid. They will be too jealous to learn from the great innovators. They will be too pig headed to discover the brilliant young engineer who changes the world before she does. They will be too cynical to inspire anybody to do anything great. They will be the ones who history ridicules.

Don’t hate, create.

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The Shana Fisher Competitive Advantage

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It ain’t what you know, it’s what you feel
Don’t worry about being right, just be for real
—Parliament, “Ride On”

Today we are announcing Shana Fisher as a new board partner at Andreessen Horowitz. Although she keeps a low profile, people in high tech investing know all about Shana. They know about her because she is so good at what she does. As an early stage investor, she has invested in a broad set of outstanding companies including MakerBot, Pinterest, Vine, FiftyThree, Refinery29 and Stripe.

Shana_Fisher_web.jpgIn addition, she is our kind of investor—one who combines the street smarts of how to build companies with the book smarts of how to invest in them. She first became involved in the Internet when she downloaded Mosaic. At a16z, we also have a high affinity for Mosaic and its bald headed co-inventor. After understanding the Internet, she became program manager at Microsoft. Later she went on to become a Vice President of Technology and Media M&A at Allen & Company, and then she led strategic planning and mergers and acquisitions at IAC before starting High Line Venture Partners, her own early stage investing business.

Perhaps the most difficult thing to do in high-tech venture investing is to identify winning consumer products before they have traction, yet Shana has done this as consistently as anyone over the past 3 years. Even more amazingly, she’s done it across a broad variety of categories from 3D printing to payments.

When I asked Shana how she figured out which consumer companies would succeed so early in their lifecycle, her answer surprised me. She said, “I understand the markets and products and technology from my background, but I don’t think that I evaluate them better than others. That’s not my competitive differentiation.” She explained: “When entrepreneurs come to me, they come with an idea and a product. No team, no traction. So, I evaluate the entrepreneur and the product. I’d like to think that I have a strong grasp of human psychology. I really try to understand what great entrepreneurs have in them, and I look for the ones who have it, and then I do what I can to help them realize their greatness.”

In talking to the many entrepreneurs that we have in common, Shana definitely helps them become great. So much so that she is their first request as a new board member, which makes this partnership a natural.

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Cash Flow and Destiny

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Wait ’til I get my money right
Then you can't tell me nothing, right?
—Kanye West, “Can’t Tell Me Nothing”

If you are an entrepreneur, you have probably heard some crusty old CEO or investor say something like “cash is king.” You probably read the Twitter S-1 and thought to yourself: “What the hell are those old guys talking about?” Twitter is still burning cash six years after founding and they, not cash, seem to be king.

In a situation such as this, I usually just say to myself: “That’s the problem with wisdom, you can get it, but you cannot share it.” But this particular nugget is so fundamentally important that I will attempt to represent the old guys in this imaginary conversation.

I was a founder/CEO during the period when cash seemed more like a serf than a king in 1999 and 2000. It was the era of “go big or go home.” Investors loved anything Internet and could not care less about profits. I grew my company and I grew it fast. In less than nine months after founding, I booked a $27 million quarter. I was going big and definitely not going home.

Then the dot com crash happened and investors changed their collective minds. Investors hated anything Internet and wouldn’t fund anything that couldn’t fund itself.

After two years of struggle, three layoffs and very little sleep, we got the company in a position to potentially generate cash. But at that point, doing so was still an open question. We had tough competitors and lots of work to do and still had plenty of time before becoming insolvent. Still, when Marc Andreessen, my co-founder and chairman of the board, said we should start generating cash, something told me that he was right.

When I sat down with my team and told them that we would generate positive cash flow no later than Q2 of 2003 and I planned to commit that to Wall Street, one of the best people on my team questioned the direction. He pointed to our low cash burn, money in the bank and long list of urgent features to be completed. He asked, “Why draw a line in the sand if we don’t have to?” Sometimes it takes a tough question like that to gather one’s thoughts. My response then is my response now to entrepreneurs who ask me this question:

“We should first decide how much we like laying people off, because if we love it then lets stay cash flow negative, because when we don’t generate cash, the capital markets decide when we have to lay people off. In fact, we will have to listen very carefully to investors on everything because as soon as they stop liking us, we will start dying. I don’t know about you, but I do not want to live my life that way. I do not want to have to tell all of our employees that we will do what we think is right until investors tell us we have to do otherwise. I want to control my destiny.”

The manager didn’t even have to reply, because his eyes told me that he knew what I was talking about. This wasn’t about strategy or tactics; this was about freedom. The freedom to build the company the way we thought was best.

Over the next five years, investors wanted us to do lots of things. Some things they wanted were smart and some very stupid. We listened to what they had to say, but we always did what we thought was right and we never worried about the consequences. Investors did not control our destiny. Over those five years the company’s value grew 40-fold as a result of controlling our own destiny and being able to make our own decisions.

There are many examples of companies that finance their way through massive profitless growth. In the right circumstances and with the right company, this can be a good strategy. For companies like Twitter, it’s a good strategy for two reasons. First, they're building something massively important with every rational expectation that it is spring-loaded to generate huge amounts of cash in the future. Second, the capital markets over the last six years have been willing to support them (as compared to the capital markets between 2000 and 2006 which wouldn't have).  So, if you are just like Twitter and if you are in this era, everything works beautifully.

However, if you are not Twitter or if times change, then be careful. Until you generate cash, you must heed investors even when they are wrong. If investors wake up one day and think you are toast, you are indeed toast. When you generate cash, you can respond to silly requests from the capital markets the way Kanye would:

Excuse me, is you saying something?
Uh uh, you can't tell me nothing

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