August 2023 - Capital Returns by Edward Chancellor

We dive into an investing book that covers the capital cycle. In summary, the best time to invest in a sector is actually when capital is leaving or has left.

Tech Themes

Amazon. Marathon understands that the world moves in cycles. During the internet bubble of the late 1990s the company refused to invest in a lot of speculative internet companies. “At the time, we were unable to justify the valuations of any of these companies, nor identify any which could safely say would still be going strong in years to come.” In August of 2007, however, several years after the internet bubble burst, they noticed Amazon again. Amazon’s stock had rebounded well from the lows of 2001 and was roughly flat from its May 1999 valuation. Sales had grown 10x since 1999 and while they recognized it had a tarnished reputation from the internet bubble, it was actually a very good business with a negative working capital cycle. On top of this, the reason the stock hadn’t performed well in the past few years was because they were investing in two new long-term growth levers, Amazon Web Services and Fulfillment by Amazon. I’m sure Marathon underestimated the potential for these businesses but we can look back now and know how exceptional and genius these margin lowering investments were at the time.
Semis. Nothing paints a more clear picture of cyclicality than semiconductors. Now we can debate whether AI and Nvidia have moved us permanently out of a cycle but up until 2023, Semiconductors was considered cyclical. As Marathon notes: “Driven by Moore’s law, the semiconductor sector has achieved sustained and dramatic performance increases over the last 30years, greatly benefiting productivity and the overall economy. Unfortunately, investors have not done so well. Since inception in 1994, the Philadelphia Semiconductor Index has underperformed the Nasdaq by around 200 percentage point, and exhibited greater volatility…In good times, prices pick up, companies increase capacity, and new entrants appear, generally from different parts of Asia (Japan in the 1970s, Korea in 1980s, Taiwan in the mid1990s, and China more recently). Excess capital entering at cyclical peaks has led to relatively poor aggregate industry returns.” As Fabricated Knowledge points out the 1980s had two brutal Semiconductor cycles. First, in 1981, the industry experienced severe overcapacity, leading to declining prices while inflation ravaged through many businesses. Then in 1985, the US semiconductor business declined significantly. “1985 was a traumatic moment for Intel and the semiconductor industry. Intel had one of the largest layoffs in its history. National Semi had a 17% decrease in revenue but moved from an operating profit of $59 million to an operating loss of -$117 million. Even Texas Instruments had a brutal period of layoffs, as revenue shrank 14% and profits went negative”. The culprit was Japanese imports. Low-end chips had declined significantly in price, as Japan flexed its labor cost advantage. All of the domestic US chip manufacturers complained (National Semiconductor, Texas Instruments, Micron, and Intel), leading to the 1986 US-Japan Semiconductor Agreement, effectively capping Japanese market share at 20%. Now, this was a time when semiconductor manufacturing wasn’t easy, but easier than today, because it focused mainly on more commoditized memories. 1985 is an interesting example of the capital cycle compounding when geographic expansion overlaps with product overcapacity (as we had in the US). Marathon actually preferred Analog Devices, when it published its thesis in February 2013, highlighting the complex production process of analog chips (physical) vs. digital, the complex engineering required to build analog chips, and the low-cost nature of the product. “These factors - a differentiated product and company specific “sticky” intellectual capital - reduce market contestability….Pricing power is further aided by the fact that an analog semiconductor chip typically plays a very important role in a product for example, the air-bag crash sensor) but represents a very small proportion of the cost of materials. The average selling price for Linear Technology’s products is under $2.” Analog Devices would acquire Linear in 2017 for $14.8B, a nice coda to Marathon’s Analog/Linear dual pitch.
Why do we have cycles? If everyone is playing the same business game and aware that markets come and go, why do we have cycles at all. Wouldn’t efficient markets pull us away from getting too hyped when the market is up and too sour when the market is down? Wrong. Chancellor gives a number of reasons why we have a capital cycle: Overconfidence, Competition Neglect, Inside View, Extrapolation, Skewed Incentives, Prisoner’s Dilemma, and Limits to Arbitrage. Overconfidence is somewhat straightforward - managers and investors look at companies and believe they are infallible. When times are booming, managers will want to participate in the boom, increasing investment to match “demand.” In these decisions, they often don’t consider what their competitors are doing, but rather focus on themselves. Competition neglect takes hold as managers enjoy watching their stock tick up and their face be splattered across “Best CEO in America” lists. Inside View is a bit more nuanced, but Michael Mauboussin and Daniel Kahneman have written extensively on it. As Kahneman laid out in Thinking, Fast & Slow: “A remarkable aspect of your mental life is that you are rarely stumped … The normal state of your mind is that you have intuitive feelings and opinions about almost everything that comes your way. You like or dislike people long before you know much about them; you trust or distrust strangers without knowing why; you feel that an enterprise is bound to succeed without analyzing it.” When you take the inside view, you rely exclusively on your own experience, rather than other similar situations. Instead, you should take the outside view and assume your problem/opportunity/case is not unique. Extrapolation is an extremely common driver of cycles, and can be seen all across the investing world after the recent COVID peak. Peloton, for example, massively over-ordered inventory extrapolating out pandemic related demand trends. Skewed incentives can include near-term EPS targets (encourages buybacks, M&A), market share preservation (encourages overinvestment), low cost of capital (buy something with cheap debt), analyst expectations, and champion bias (you’ve decided to do something and its no longer attractive, but you do it anyway because you got people excited about it). The Prisoner’s Dilemma is also a form of market share preservation/expansion, when your competitor may be acting much more aggressively and you have to decide whether its worth the fight. Limits to Arbitrage is almost an extension of career risk, in that, when everyone owns an overvalued market, you may actually hurt your firm by actively withholding even if it makes investment sense. That’s why many firms need to maintain a low tracking error against indexes, which can naturally result in concentrations in the same stocks.

Business Themes

Capital Cycle. The capital cycle has four stages: 1. New entrants attracted by prospect of high returns: investor optimistic 2. Rising competition causes returns to fall below cost of capital: share price underperforms 3. Business investment declines, industry consolidation, firms exit: investors pessimistic 4. Improving supply side causes returns to rise above the cost of capital: share price outperforms. The capital cycle reveals how competitive forces and investment behavior create predictable patterns in industries over time. Picture it as a self-reinforcing loop where success breeds excess, and pain eventually leads to gain. Stage 1: The Siren Song - High returns in an industry attract capital like moths to a flame. Investors, seeing strong profits and growth, eagerly fund expansions and new entrants. Optimism reigns and valuations soar as everyone wants a piece of the apparent opportunity. Stage 2: Reality Bites - As new capacity comes online, competition intensifies. Prices fall as supply outpaces demand. Returns dip below the cost of capital, but capacity keeps coming – many projects started in good times are hard to stop. Share prices begin to reflect the deteriorating reality. Stage 3: The Great Cleansing - Pain finally drives action. Capital expenditure is slashed. Weaker players exit or get acquired. The industry consolidates as survivors battle for market share. Investors, now scarred, want nothing to do with the sector. Capacity starts to rationalize. Stage 4: Phoenix Rising - The supply-side healing during the downturn slowly improves industry economics. With fewer competitors and more disciplined capacity, returns rise above the cost of capital. Share prices recover as improved profitability becomes evident. But this very success plants the seeds for the next cycle. The genius of understanding this pattern is that it's perpetual - human nature and institutional incentives ensure it repeats. The key is recognizing which stage an industry is in, and having the courage to be contrarian when others are either too optimistic or too pessimistic.
7 signs of a bubble. Nothing gets people going more than Swedish Banking in the 2008-09 financial crisis. Marathon called out its Seven Deadly Sins of banking in November 2009, utilizing Handelsbanken as a positive reference, highlighting how they avoided the many pitfalls that laid waste to their peers. 1. Imprudent Asset-Liability mismatches on the balance sheet. If this sounds familiar, its because its the exact sin that took down Silicon Valley Bank earlier this year. As Greg Brown lays out here: “Like many banks, SVB’s liabilities were largely in the form of demand deposits; as such, these liabilities tend to be short term and far less sensitive to interest rate movement. By contrast, SVB’s assets took the form of more long-term bonds, such as U.S. Treasury securities and mortgage-backed securities. These assets tend to have a much longer maturity – the majority of SVB’s assets matured in 10 years or more – and as a result their prices are much more sensitive to interest rate changes. The mismatch, then, should be obvious: SVB was taking in cash via short-term demand deposits and investing these funds in longer-term financial instruments.” 2. Supporting asset-liability mismatches by clients. Here, Chancellor calls out foreign currency lending, whereby certain European banks would offer mortgages to Hungarians in swiss francs, to buy houses in Hungary. Not only were these banks taking on currency risk, they were exposing their customers to it and many didn’t hedge the risk out appropriately. 3. Lending to “Can’t Pay, Won’t Pay” types. The financial crisis was filled with banks lending to subprime borrowers. 4. Reaching for growth in unfamiliar areas. As Marathon calls out, “A number of European banks have lost billions investing in US subprime CDOs, having foolishly relied on “experts” who told them these were riskless AAA rated credits.” 5. Engaging in off-balance sheet lending. Many European banks maintained "Structured Investment Vehicles” that were off-balance sheet funds holding CDOs and MBSs. At one point, it got so bad that Citigroup tried the friendship approach: “The news comes as a group of banks in the U.S. led by Citigroup Inc. are working to set up a $100 billion fund aimed at preventing SIVs from dumping assets in a fire sale that could trigger a wider fallout.” These SIVs held substantial risk but were relatively unknown to many investors. 6. Getting sucked into virtuous/vicious cycle dynamics. As many European banks looked for expansion, they turned to lending into the Baltic states. As more lenders got comfortable lending, GDP began to grow meaningfully, which attracted more aggressive lending. More banks got suckered into lending in the area to not miss out on the growth, not realizing that the growth was almost entirely debt fueled. 7. Relying on the rearview mirror. Marathon points out how risk models tend to fail when the recent past has been glamorous. “In its 2007 annual report, Merrill Lunch reported a total risk exposure - based on ‘a 95 percent confidence interval and a one day holding period’ - of $157m. A year later, the Thundering Herd stumbled into a $30B loss!”
Investing Countercyclically. Björn Wahlroos exemplified exceptional capital allocation skills as CEO of Sampo, a Finnish financial services group. His most notable moves included perfectly timing the sale of Nokia shares before their collapse, transforming Sampo's property & casualty insurance business into the highly profitable "If" venture, selling the company's Finnish retail banking business to Danske Bank at peak valuations just before the 2008 financial crisis, and then using that capital to build a significant stake in Nordea at deeply discounted prices. He also showed remarkable foresight by reducing equity exposure before the 2008 crisis and deploying capital into distressed commercial credit, generating €1.5 billion in gains. Several other CEOs have demonstrated similar capital allocation prowess. Henry Singleton at Teledyne was legendary for his counter-cyclical approach to capital allocation. He issued shares when valuations were high in the 1960s to fund acquisitions, then spent the 1970s and early 1980s buying back over 90% of Teledyne's shares at much lower prices, generating exceptional returns for shareholders. As we saw in Cable Cowboy, John Malone at TCI (later Liberty Media) was masterful at using financial engineering and tax-efficient structures to build value. He pioneered the use of spin-offs, tracking stocks, and complex deal structures to maximize shareholder returns while minimizing tax impacts. Tom Murphy at Capital Cities demonstrated exceptional discipline in acquiring media assets only when prices were attractive. His most famous move was purchasing ABC in 1985, then selling the combined company to Disney a decade later for a massive profit. Warren Buffett at Berkshire Hathaway has shown remarkable skill in capital allocation across multiple decades, particularly in knowing when to hold cash and when to deploy it aggressively during times of market stress, such as during the 2008 financial crisis when he made highly profitable investments in companies like Goldman Sachs and Bank of America. Jamie Dimon at JPMorgan Chase has also proven to be an astute capital allocator, particularly during crises. He guided JPMorgan through the 2008 financial crisis while acquiring Bear Stearns and Washington Mutual at fire-sale prices, significantly strengthening the bank's competitive position. D. Scott Patterson has shown excellent capital allocation skills at FirstService. He began leading FirstService following the spin-off of Colliers in 2015, and has compounded EBITDA in the high teens via strategic property management acquistions coupled with large platforms like First OnSite and recently Roofing Corp of America. Another great capital allocator is Brad Jacobs. He has a storied career building rollups like United Waste Systems (acquired by Waste Services for $2.5B), United Rentals (now a $56B public company), XPO logistics which he separated into three public companies (XPO, GXO, RXO), and now QXO, his latest endeavor into the building products space. These leaders share common traits with Wahlroos: patience during bull markets, aggression during downturns, and the discipline to ignore market sentiment in favor of fundamental value. They demonstrate that superior capital allocation, while rare, can create enormous shareholder value over time.
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July 2023 - The Myth of Capitalism by Jonathan Tepper with Denise Hearn

We learn about the fun history of many monopolies and anti-trust! While I can’t recommend this book because its long and poorly written, it does reasonably critique aspects of antitrust and monopoly formation. Its repetitive and so aggressively one-sided that it loses credibility. The fact that the author used to advise and now runs a hedge fund that owns monopoly businesses tells you all you need to know.

Tech Themes

Consumer Welfare. Tepper’s fundamental argument is that since the 1980s, driven by Regan’s deregulation push, the government has allowed corporate mergers and abuses of market power, leading to more market concentration, higher prices, greater inequality, worse worker conditions, and stymied innovation. Influenced by the Chicago School’s free market ideas and Robert Bork’s popular 1978 book Antitrust Paradox, the standard for antitrust enforcement morphed from breaking up market-abusing companies to “consumer welfare.” With this shift, antitrust enforcement became: “Does this harm the consumer?” A lot of things do not harm consumers. Broadcast Music, Inc. v. CBS, Inc. (1979) is widely regarded as one of the first antitrust cases that shifted the Rule of reason towards consumer welfare. CBS had sued Broadcast Music, alleging that blanket licenses constituted price fixing. Broadcast Music represented copyright holders and would grant licenses to media companies to use artist’s music on air. These deals were negotiated on behalf of many artists, and did not allow CBS to negotiate for selected works. The court sided with BMI because the blanket license process was simpler, lowered transaction costs by reducing the number of negotiations, and allowed broadcasters greater access to works. They even admitted that the blanket license may be a form of price setting, but concluded that it didn’t necessarily harm consumers and was more efficient, so they allowed it. The consumer welfare ideology has recently come under fire around the big tech companies - Apple, Microsoft, Google, Meta, and Amazon. Lina Khan, Commissioner of the Federal Trade Commission (FTC) wrote a powerful and aptly titled article, Amazon’s Antitrust Paradox, highlighting why in her view consumer welfare was not a strong enough stance on antitrust. “This Note argues that the current framework in antitrust—specifically its pegging competition to “consumer welfare,” defined as short-term price effects—is unequipped to capture the architecture of market power in the modern economy.” The note argues that Amazon’s willingness to offer unsustainably low prices and their role as a marketplace platform and a seller on that marketplace allow it crush competition. Google is currently being sued by the Department of Justice over illegal monopolization of adtech and its dominance in the search engine market. The government is attempting to shift antitrust back to a more aggressive approach regarding monopolistic behavior. From a consumer welfare perspective, there is no doubt that all of these companies have created situations that benefit consumers (“free” services, low prices) and hurt competition. The question is: “Is it illegal?”
The ACTs - Sherman and Clayton. The Sherman Antitrust Act, passed in 1890, was the first major federal law aimed at curbing monopolies and promoting competition. The late 19th century, often referred to as the Gilded Age, saw the rise of powerful industrialists like J.P. Morgan, John D. Rockefeller, and Cornelius Vanderbilt, whose massive corporations threatened to dominate key sectors of the economy. Public outcry over the potential for these monopolies to stifle competition and exploit consumers led to the passage of the Sherman Act. Senator John Sherman, intended the law to protect the public from the negative consequences of concentrated economic power. The Sherman Act broadly prohibited anticompetitive agreements and monopolization, empowering the government to break up monopolies and prevent practices that restrained trade. However, the Sherman Act's broad language left it open to interpretation, and its early enforcement was inconsistent. President Theodore Roosevelt, a proponent of trust-busting, used the Sherman Act to challenge powerful monopolies, such as the Northern Securities Company, a railroad conglomerate controlled by J.P. Morgan. The Supreme Court's decision in the Standard Oil case in 1911 further shaped the interpretation of the Sherman Act, establishing the "rule of reason" as the standard for evaluating antitrust violations. This meant that not all restraints of trade were illegal, only those that were deemed "unreasonable" in their impact on competition. The Clayton Antitrust Act, passed in 1914, was designed to strengthen and clarify the Sherman Act. It specifically targeted practices not explicitly covered by the Sherman Act, such as mergers and acquisitions that could lessen competition, price discrimination, and interlocking directorates. The Clayton Act also sought to protect labor unions, which had been subject to antitrust prosecution under the Sherman Act. The passage of these acts led to a wave of significant antitrust cases. Prominent examples include: United States v. American Tobacco Co. (1911): This case resulted in the breakup of the American Tobacco Company, a dominant force in the tobacco industry, demonstrating the government's commitment to using antitrust laws to dismantle powerful monopolies. United States v. Paramount Pictures, Inc. (1948): This case challenged the vertical integration of the film industry, where major studios controlled production, distribution, and exhibition. The court's decision led to significant changes in the industry's structure. United States v. AT&T Co. (1982): This landmark case resulted in the breakup of AT&T, a telecommunications giant, into smaller, regional companies. This case marked a major victory for antitrust enforcement and had a lasting impact on the telecommunications industry.
Microsoft. The Microsoft antitrust case, initiated in October 1998, saw the U.S. government accusing Microsoft of abusing its monopoly power in the personal computer operating systems market. The government, represented by David Boies (yes, Theranos David Boies), argued that Microsoft, led by Bill Gates, had engaged in anti-competitive practices to stifle competition, particularly in the web browser market. Gates was famously deposed and shockingly (not really) came away from the deposition looking like an asshole. The government alleged that Microsoft violated the Sherman Act by: Bundling its Internet Explorer (IE) web browser with its Windows operating system, thereby hindering competing browsers like Netscape Navigator, manipulating application programming interfaces to favor IE, and enforcing restrictive licensing agreements with original equipment manufacturers, compelling them to include IE with Windows. Judge Thomas Jackson presided over the case at the United States District Court for the District of Columbia. In 1999, he ruled in favor of the government, finding that Microsoft held a monopoly and had acted to maintain it. He ordered Microsoft to be split into two units, one for operating systems and the other for software components. Microsoft appealed the decision. The Appeals Court overturned the breakup order, partly due to Judge Jackson's inappropriate discussions with the media. While upholding the finding of Microsoft's monopolistic practices, the court deemed traditional antitrust analysis unsuitable for software issues. The case was remanded to Judge Colleen Kollar-Kotelly, and ultimately, a settlement was reached in 2001. The settlement mandated Microsoft to share its application programming interfaces with third-party companies and grant a panel access to its systems for compliance monitoring. However, it did not require Microsoft to change its code or bar future software bundling with Windows. This led to criticism that the settlement was inadequate in curbing Microsoft's anti-competitive behavior. History doesn’t repeat itself, but it does rhyme and Microsoft is doing the exact same bundling strategy again with its Teams app.

Business Themes

Monopoly Markets. Tepper lays out all of the markets that he believes are monopoly, duopoly, or oligopoly markets. Cable/high speed internet (Comcast, Verizon, AT&T, Charter (Spectrum)) - pretty much the same, Computer Operating Systems (Microsoft) - pretty much the same but iOS and Linux are probably bigger, Social Networks (Facebook with 75% share). Since then Tiktok, Twitter, Pinterest, and Snap have all put a small dent in Facebook’s share. Search (Google), Milk (Dean Foods), Railroads (BNSF, NSC, CSX, Union Pacific, Kansas City Southern), Seeds (Bayer/Monsanto, Syngenta/ChemChina, Dow/DuPont), Microprocessors (Intel 80%, AMD 20%), Funeral Homes (Service Corporation International) all join the monopoly club. The duopoly club consists of Payment Systems (Visa, Mastercard), Beer (AB Inbev, Heineken), Phone Operating Systems (iOS, Android), Online Advertising (Google, Facebook), Kidney Dialysis (DaVita), and Glasses (Luxottica). The oligopoly club is Credit Reporting Bureaus (Transunion, Experian, FICO), Tax Preparation (H&R Block, Intuit), Airlines (American, Delta, United, Southwest, Alaska), Phone Companies (Verizon, Sprint, T-Mobile, AT&T), Banks (JP Morgan Chase, Bank of America, Citigroup, Wells Fargo), Health Insurance (UnitedHealthcare, Centene, Humana, Aetna), Medical Care (HCA, Encompass, Ascension, Universal Health), Group Purchasing Organizations (Vizient, Premier, HealthTrust, Intaler), Pharmacy Benefit Managers (Express Scripts, CVS Caremark, Optum/UnitedHealthcare), Drug Wholesalers (Cencora, McKesson, Cardinal Health), Agriculture (ADM, Bunge, Cargill, Louis Dreyfus), Media (Walt Disney, Time Warner, CBS, Viacom, NBC Universal, News Corp), Title Insurance (Fidelity National, First American, Stewart, and Old Republic). Since the book was published in 2018, there has been even more consolidation - Canadian Pacific bought Kansas City Southern for $31B, Essilor merged with Luxottica in 2018 in a $49B deal, Sprint merged with T-Mobile in a $26B deal, and CBS and Viacom merged in a $30B deal. Tepper’s anger towards lackadaisical enforcement of antitrust is palpable. He encourages greater antitrust speed and transparency, the unwinding of now clear market consolidating mergers, and the breakup of local monopolies.
Conglomeration and De-Conglomeration. Market Concentration. The conglomerate boom, primarily occurring in the 1960s, saw a surge in the formation of large corporations encompassing diverse, often unrelated businesses. This era was fueled by low interest rates and a fluctuating stock market, creating favorable conditions for leveraged buyouts. A key driver of this trend was the Celler-Kefauver Act of 1950, which, by prohibiting companies from acquiring their competitors or suppliers, pushed them towards diversification through acquiring businesses in unrelated fields. The prevailing motive was to achieve rapid growth, even if it meant prioritizing revenue growth over profit growth. Conglomerates were seen as a means to mitigate risk through diversification and achieve operational economies of scale. Many conglomerates formed that operated across completely different industries: Gulf and Western (Paramount Pictures, Simon & Schuster, Sega, Madison Square Garden), ITT (Telephone companies, Avis, Wonder Bread, Hartford Insurance, and Sheraton), and Henry Singleton’s Teledyne. However, the conglomerate era ultimately waned. The government took a more proactive approach to acquisitions in the late 1960s, curbing the aggressive approaches. The FTC sued Proctor & Gamble over its potential acquisition of Clorox and merger guidelines were revised in 1968, setting out more rules against market share and concentration. Rising interest rates in the 1970s strained these sprawling enterprises, forcing them to divest many of their acquisitions. The belief in the inherent efficiency of conglomerates was challenged as businesses increasingly favored specialization over sprawling, unwieldy structures. The concept of synergy, once touted as a key advantage of conglomerates, came under scrutiny. Ultimately, the conglomerate era was marked by performance dilution, value erosion, and the realization that strong performance in one business did not guarantee success in unrelated sectors.
Industry Concentration. A central pillar to Tepper’s argument that the capitalism game isn’t being played fairly or appropriately, is that rising industry concentration is worrisome and indicative of a broken market system. He uses the Herfindahl-Hirschman Index (HHI) to discuss levels of industry concentration. According to the Antitrust Division at the DOJ: “The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. For example, for a market consisting of four firms with shares of 30, 30, 20, and 20 percent, the HHI is 2,600 (302 + 302 + 202 + 202 = 2,600). The agencies generally consider markets in which the HHI is between 1,000 and 1,800 points to be moderately concentrated, and consider markets in which the HHI is in excess of 1,800 points to be highly concentrated.” The HHI index is relatively straightforward to calculate. It can be a quick test to see if a potential merger creates a more significantly concentrated market. However, it still falls prey to some issues. For example, market definitions are extremely important in antitrust cases and a poorly or narrowly defined market can cause the HHI to look overly concentrated. In the ongoing Kroger-Albertson’s Merger case, the FTC is proposing a somewhat narrow definition of supermarkets, which excludes large supermarket players like Walmart, Costco, Aldi, and Whole Foods. If Whole Foods isn’t a super market, I’m not sure what is. And sure, maybe they narrowly define the market because Kroger and Albertsons serve a particular niche where substitutes are not easily available. Whole Foods may be more expensive, Aldi may have limited assortment, and Costco portion sizes may be too big. However, if you have a market that has Kroger, Walmart, Costco, Aldi, and Whole Foods serving a reasonable size population, I can almost guarantee the prices are likely to remain competitive. In some cases, high industry concentration does not mean monopolistic behavior. However, it can lead to monopolistic or monopsonistic behavior including: higher prices, lower worker’s wages, lower growth, and greater inequality.
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June 2023 - The Great American Drug Deal by Peter Kolchinsky

We dive into everyone’s favorite topic - Health Insurance!

Tech Themes

Patents, Generics, Biologics. Kolchinsky, who is the founder of leading biotech investment firm, RA Capital Management, lays out what he calls the Biotech Social Contract: “The drug development industry’s commitment to developing new medicines (and other technologies) that will go generic without undue delay is reciprocated by society’s commitment to providing universal health insurance with low/no out-of-pocket costs so that patients can afford what their patients prescribe.” Let’s unpack this straight forward contract. The first major idea presented is what Kolchinsky dubs the “Mountain of Generics.” When drugs are developed, they are often patented. Per the FDA, patents are normally granted for a 20 year period. Drugs can also have exclusivity, which are marketing rights - it prevents the submission and approval of Abbreviated New Drug Applications (ANDAs) by the FDA. There are four types of exclusivity: 1 - Orphan Drug Exclusivity (7 years) for rare disases affecting <200,000 people 2 - New Chemical Exclusivity (5 years) for a new molecule that hasn’t existed before 3- Other Exclusivity for a change in new clinical investigations and 4 - Pediatric Exclusivity which is 6 months added to a patent/exclusivity when submitting pediatric study data. After patent expiration or exclusivity, drugs go “Generic”, meaning they become available in the public domain and companies can produce them without paying patent royalties. The process of going generic was fortified in the 1984 Hatch-Waxman Act, an amendment to the Price Competition and Patent Term Restoration Act. Hatch-Waxman established that generic versions of previously approved innovator drugs can be approved without a full new drug submission. This sounds laudable, and for a short time massively increased the number of generic applications. However, Hatch-Waxman’s legacy is debated. Some argue that as a result of an easier genericization process, Pharmaceutical companies raised prices on branded drugs, exploited loop-holes in patent expiration (Jazz Pharma-REMS-Xyrem), and created patent thickets of similar patents that could prolong exclusivity. Because the loss of exclusivity or patents (sometimes referred to as the patent cliff) is so significant for Pharmaceutical companies, many go to extreme lengths to protect it. Further complicating the genericization of drugs, are new types of drugs known as biologics, which are not straightforward chemical formations (known as small molecule) but rather living engineered cells that are not effectively replicable. Because biologics are not a simple formulaic drug, genericization has actually been prolonged and biosimilars (generic biologics) have not come to market nearly as quickly as prior small molecule generic drugs. Humira, a $20B/year drug owned by Abbive, has sued multiple companies over genericization of its patents, leading to in some cases seven years of additional patent exclusivity. At $25B of sales, the biggest drug in the world is Merck’s Keytruda (used for treating cancer), whose patent expires in 2028. When drugs become generic, there is normally a fairly steep drop off in sales. Lipitor, Pfizer’s famous cholesterol statin generated $12.5B in sales at peak, but following patent expiration in 2011, dropped from $9.5B to just over $3B. Kolchinsky believes that we should celebrate the process of going generic. In his mind, as drugs become generic, they are added to our armory of infection fighting weaponry at much cheaper prices for everyone to access and benefit from. He believes we should incentivize going generic sooner, through upfront payments (6 months of sales) and close many of the patent loop-holes and litigation techniques that have allowed Pharma companies to continually prolong genericization.
Prices. Nobody ever says drug prices are reasonable. They are always too high. While we layout the reason why the system incentivizes higher prices below, let’s talk about some of the confusing aspects of drug prices. First of all, lets clearly state that retail prescription drug costs were about 9% of overall healthcare expenditure in 2022. Kolchinsky discussed; “Collectively, service-related costs account for the vast majority of healthcare spending, over 70%, far more than we spend on drugs.” While patented monopolies have pushed drug prices higher, hospital care, physician services, nursing facilities, and other healthcare services spend is unimaginably bloated and is a big driver of increased healthcare costs. As he points out, if all currently branded drugs went generic, and prices fell by 90%, that would be a one-time 6.7% reduction in healthcare spending. Billions of dollars for sure, but not as drastic a reduction as you would imagine. One of the big challenges with drug prices stems from how costs are negotiated between Pharmaceutical companies, distributors (Cencora, Mckesson, Cardinal) payers (insurance companies or government bodies like CMS (i.e. Medicare and Medicaid)), and Pharmacy Benefit Managers (PBMs). The complicated miasma of different players causes obfuscation of prices but effectively there are gross prices and net prices. Net prices factor in rebates paid to PBMs and discounts offered to payers. Headline average list prices tend to go up every year with inflation or demand, but net prices can come down if payers negotiate more effectively. When we hear of price gouging, its not always clear whether we are talking about gross or net prices, and exactly why prices could go up for medications. Sometimes it is pure price gouging like Turing Pharmaceuticals in 2015. Other times, a drug may have been covered under a certain insurance plan or listed on a PBM’s formulary but is removed because the plan or PBM has negotiated better discounts on other drugs. Frequently, these are not one-for-one swaps, which causes huge headaches for patients. Another commonly, discussed issue with pricing is the increased cost of prices in the US relative to international prices. As Kolchinsky notes: “The US market accounts for roughly one third to one half of the drug industry’s revenue.” There are many causes of this 1) Administrative waste, roughly 8% of America’s budget is on administration compared to 1-3% for other countries 2) Education costs and higher salaries for providers mean prices must be higher for hospital to earn margin 3) Earlier access to medical innovations created in the US and 4) the decision to never deny patients access to treatment on the basis of their ability to pay. But perhaps the biggest reason for the higher drug prices is lack of single payer leverage. In countries with universal healthcare, countries negotiate directly with pharmaceutical companies to set prices, often based on comparative treatments and improvement in effectiveness of a new drug. These countries need to be willing to walk away from new innovations but they definitely achieve better overall prices. Kolchinsky argues that: “If companies could only sell in the US, they’d have to charge about twice as much to generate the same return on investment.” The US is trialing government led drug negotiations with the new passage of the Inflation Reduction Act in 2022. It will be interesting to see what happens to prices!
Laws. There are numerous laws governing Healthcare and Pharmaceutical companies. The most important public laws include: the FD&C act of 1938 which gave authority to the FDA to regulate the safety of food, drugs, and medical devices, the 1965 Title XIX Amendment to the Social Security Act, establishing Medicare and Medicaid and their overseeing body, CMS, the Orphan Drug Act of 1983, which established longer market exclusivity and fast-track FDA approvals for drugs that target rare diseases (i.e. populations of less than 200,000 US Citizens), the American with Disabilities Act of 1990 which made it illegal to discriminate based on disabilities, the Health Insurance Portability and Accountability Act of 1996 that mandated guidelines around sharing personably identifiable information (PII) in the healthcare setting, and the Affordable Care Act (ACA) of 2010 that broadened Medicaid eligibility and created state by state insurance exchanges for citizens to find insurance. Each of these laws fundamentally changed the healthcare landscape. The Orphan Drug Act has become a major bellwether to the Pharmaceutical industry, granting market exclusivity for 7 years and allowing pharmaceutical companies to charge a fair (but normally high) cost, based on the number of patients. Because these markets serve so few patients, Pharma companies need to know that if they are successful, they will be able to charge a high-enough price to recoup their R&D investments. When you couple the high prices, low market penetration, and exclusivity, these drugs can be very strong supplements to larger mass-market drugs that dominate the large pharmaceutical companies. About half of annual new drug approvals are for Orphan diseases. These drugs can make serious money: Imbruvica (Ibrutinib - cancer), Trikafta (elexacaftor-tezacaftor-ivacaftor, Cystic Fibrosis), Lynparza (Olaparib, Ovarian Cancer) are all $5B+ drugs. Laws are always changing, and as part of the Inflation Reduction Act signed in 2022, a new law allowed DHS to negotiate prices directly with the Pharmaceutical manufacturers (going around Insurance, wholesalers, and PBMs), in an effort to reduce price growth. The first round of negotiations is set to occur in 2024 and could lead to substantial savings. The Healthcare landscape is constantly changing, to understand what’s happening, you have to follow the laws.

Business Themes

Why are drug prices so high? Incentives. Drug prices in the US are high because it behooves all players (except patients) involved to increase prices. There is a very complex web of institutions involved in the healthcare and pharmaceutical world: Pharmaceutical companies, biotech companies, insurance companies, providers (hospitals, care facilities), pharmacy benefit managers (PBMs), drug wholesalers, beneficiaries (patients) and more. Patients and plan sponsors (employers a lot of the time) pay premiums to Health Plans (insurance companies). These Health Plans pay Pharmacy Benefit Managers who negotiate which drugs are placed on the Health Plan’s formulary, or what drugs are available to patients in the plan and their cost. Pharmacy Benefit Managers sit in between insurance companies, pharmacies, wholesalers, and drug manufacturers, negotiating discounts with everyone across the chain. You may be saying: “Wow, cheaper healthcare prices would be great!” However, in practice the value of PBMs is highly debated. PBMs make money primarily through rebates and incentive payments from manufacturers. Now, here we have an incentive mismatch. PBMs are paid a percentage of the “dollars saved” for plans and the incentive payments from manufacturers. Therefore, they prefer to have very high gross prices, for which they can negotiate steep discounts and capture more rebates. In addition, they may prefer to keep higher cost branded drugs on formularies even if there are generics available. For Example, the Center for Biosimilars notes that PBMs have continued to favor Abbvie’s drug Humira despite biosimilars being available: “IQVIA had discovered that adalimumab biosimilars could have offered potential savings of up to $6 billion to the US health care system. However, transitioning all US patients to these biosimilars would have resulted in an estimated 84% decrease in PBM profits. This shift also would have posed a potential loss of revenue for large specialty pharmacies, which frequently shared corporate ownership with PBMs.” Now, there are more players who prefer higher prices in this value chain. Wholesalers make money by buying large amounts of drugs in bulk and distributing them to the pharmacies. These wholesalers tend to make higher spreads (the cost of what they buy vs. the price they sell to pharmacies) on branded drugs but more money on generics distribution, given that generics make up a much larger percentage of drugs consumed. As Pharmaceutical companies increase drug prices, wholesalers benefit because they confidentially negotiate discounts to list prices with manufacturers. They then price drugs relative to the manufacturer list price, called the Wholesale Acquisition Cost (WAC). For example, they may negotiate a 10% discount to list price, then sell drugs at WAC - 5% to pharmacies, thereby profiting 5% on the drug. Manufacturers also obviously prefer higher prices so they can make more profits. Insurance companies like higher prices overall, because they can charge higher premiums as costs rise. At each stop, the players prefer higher prices. The price issues are worsened by the industry concentration: The top 3 PBMs managed 80% of the market, the top five pharmacies are 54% of the market, the top 3 wholesalers are 90% of the market, the top 20 pharma manufacturers own 70% of the market. There are very few players and all can coordinate to raise prices continuously. Furthermore, everyone in the industry claims to be trying to lower costs and they often provide eachother as scapegoats. BCBS (an effective insurance monopoly in many states) blames the Hospitals seeking more reimbursement. Mark Cuban has started Cost Plus Drugs which hopes to circumvent this complex web of increasing prices and provide generic drugs at very cheap costs to consumers.
Insurance. The biggest issue facing health insurance in the US is the lack of coverage for large swaths of the population. Today, 7% of Americans or 25.3m people are uninsured. Because a lot of the population remains uncovered, drug costs are higher for everyone. To understand why, consider a sick patient without insurance. When they receive medical care, they will have to pay out-of-pocket. Many times, particularly in emergency settings, patients are unable to cover the costs associated with their treatment. A large swath of the uninsured population are uninsured because they do not have enough money to pay insurance premiums and co-pays. When a patient is unable to pay, the Hospital tries to collect. Experts estimate there is about $80-$140B in past due medical debt in the US. But when they can’t collect, they are forced to eat the costs of providing this service. To recoup these costs, they raises prices elsewhere. In addition, Insurance companies charge co-pays for two primary reasons 1) to prevent overutilization of care and 2) to lower premiums across their population. Co-pays do act as a deterrent to individuals seeking medical care but that creates more sick patients. Rather than utilizing a medication that would heal an issue, a patient may not be able to afford the copay and elect to not take the medicine. In a few years, the condition worsens and they have a prolonged hospital stay which costs them significantly more than the combined copay costs. There should be some copay for doctor visits to modestly deter frequent vistits but drug costs should definitely not have associated copays. Copays create sicker populations. Kolchinsky proposes getting everyone insured and removing copays on prescription medications, which he believes will lessen medical debt, lower the out of pocket costs of healthcare, and increase the health of the US population. Another challenging aspect of insurance, is the concentration within states. The 2023 Competition in US Health Insurance Markets showed that 73% of commercial markets were highly concentrated. Concentration increases market power and allows insurers to charge higher premiums. For example, Blue Cross Blue Shield insurers, which are licensed in single states, are the largest plans in 41 states. Concentration raises premiums and lowers the prices paid to physicians, allowing insurance companies to make more profit. Another challenge is vertical integration. UnitedHealthcare has a 14% market share in the US (the largest), but it is also a physician network, a data analytics company, and a large PBM. They have utilized their data and wide range of services to gouge individuals and governments, by bill-coding for services and treatments that patients don’t actually need. Health Insurance is in need of major changes.
Pharma Marketing. Historically, Pharmaceutical companies promoted drugs directly to patients. However, in the early 1980s, as this practice became more widespread and egregious, the FDA eventually shut down DTC ads. It eventually came out with regulations surrounding advertising: Claims 1) cannot be false or misleading 2) must present a balance of risks and benefits 3) must state facts that are material to the advertised uses; and 4) must include every risk from the product’s approved labeling. Marketing to consumers can be dangerous. It could lead consumers into inappropriately asking for specific drugs they’ve been marketed and make it seem like drugs will always fix the specific conditions they are trying to treat. Pharmaceutical companies also market directly to physicians. As with DTC advertising, physician marketing has its issues. It could make medical professionals aware of new medications and help educate them about new treatments. But it can also devolve into kick-back schemes and unintend consequences. Let’s review a positive and negative example of Pharma marketing. EpiPen’s were first approved in 1987 and were initially sold at a low price, generally going underperscribed by the medical community. In 2007, Mylan acquired the generics business of Merck KGaA for $6.7B. EpiPen, now 20 years past approval was now a generic medication. Mylan still viewed EpiPen’s as underutilized by society. Through three net price increases, they grew EpiPen’s cost and profits, but used the excess funds to market the appliance aggressively and lobby for laws that required EpiPen training for schools. This grew EpiPen into a $1B drug by 2018. Today, EpiPen’s are still a ~$800m per year drug. While the raising costs for generic medications is certainly profit-seeking, growing knowledge and usage of potentially life-saving EpiPens is commendable. But similar tactics with a different drug created disastrous results. Purdue Pharma, the makers of the highly addictive opioid OxyContin, aggressively marketed their drugs through weekend physician meetings, dinners, conferences, and aggressive medical ads. Furthermore, the Purdue executives got the FDA to include a label that stated “Delayed absorption, as provided by OxyContin tablets, is believed to reduce the abuse liability of a drug.” These aggressive marketing and lobbying practices that supposed the drug was not addictive got thousands of individuals hooked on the drugs, created the opioid abuse scandals of the last decades. Purdue has faced over $8B in fines and $634m in individual fines for all of its perverse marketing practices. Pharma marketing is ultimately a good and bad thing. When abused its horrendous, when used properly it can promote the up-take of helpful medications.
Dig Deeper

May 2023 - Constellation Software Letters by Mark Leonard

We cover Canada’s biggest and quietest software company and their brilliant leader Mark Leonard.

Tech Themes

Critics and Critiques. For a long time, Constellation heard the same critiques: Roll-ups never work, the businesses you are buying are old, the markets you are buying in are small, the delivery method of license/maintenance is phasing out. All of these are valid concerns. Constellation is a roll-up of many software businesses. Roll-ups, aka acquiring several businesses as the primary method of growth, do have tendency to blow up. The most frequent version for a blowup is leverage. Companies finance acquisitions with debt and eventually they make a couple of poor acquisition decisions and the debt load is too big, and they go bankrupt. A recent example of this is Thrashio, an Amazon third party sellers roll-up. RetailTouchPoints lays out the simple strategy: “Back in 2021, firms like Thrasio were able to buy these Amazon-based businesses for around 4X to 6X EBITDA and then turn that into a 15X to 25X valuation on the combined business.” However, demand for many of these products waned in the post-pandemic era, and Thrasio had too much debt to handle with the lower amount of sales. Bankruptcy isn’t all bad - several companies have emerged from bankruptcy with restructured debt, in a better position than before. To avoid the issue of leverage, Constellation has never taken on meaningful (> 1-2x EBITDA) leverage. This may change in the coming years, but for now it remains accurate. Concerns around market size and delivery method (SaaS vs. License/Maintenance) are also valid. Constellation has software businesses in very niche markets, like boating maintenance software that are inherently limited in size. They will never have a $1B revenue boat maintenance software business, the market just isn’t that big. However, the lack of enthusiasm over a small niche market tends to offer better business characteristics - fewer competitors, more likely adoption of de-facto technology, highly specialized software that is core to a business. Constellation’s insight to combine thousands of these niche markets was brilliant. Lastly, delivery methods have changed. Most customers now prefer to buy cloud software, where they can access technology through a browser on any device and benefit from continuous upgrades. Furthermore, SaaS businesses are subscriptions compared to license maintenance businesses where you pay a signficant sum for the license up-front and then a correspondingly smaller sum for maintenance. SaaS subscriptions tend to cost more over the long-term and have less volatile revenue spikes, but can be less profitable because of the need to continuously improve products and provide the service 24/7. Interestingly, Constellation continued to avoid SaaS even after it was the dominant method of buying software. From the 2014 letter: “The SaaS’y businesses also have higher organic growth rates in recurring revenues than do our traditional businesses. Unfortunately, our SaaS’y businesses have higher average attrition, lower profitability and require a far higher percentage of new name client acquisition per annum to maintain their revenues. We continue to buy and invest in SaaS businesses and products. We'll either learn to run them better, or they will prove to be less financially attractive than our traditional businesses - I expect the former, but suspect that the latter will also prove to be true.” While 2014 was certainly earlier in the cloud transformation, its not surprising that an organization built around the financial characteristics of license maintenance software struggled to make this transition. They are finally embarking on this journey, led their by their customers, and its causing license revenue to decline. License revenue has declined each of the last six quarters. The critiques are valid but Constellations assiduousness allowed them to side-step and even benefit from these critics as they scaled.
Initiatives, Investing for Organic Growth, and Measurement. Although Leonard believes that organic growth is an important measure of success of a software company, he lays out in the Q1’07 letter the challenges of Constellation’s internal organic growth projects, dubbed Initiatives. “In 2003, we instituted a program to forecast and track many of the larger Initiatives that were embedded in our Core businesses (we define Initiatives as significant Research & Development and Sales and Marketing projects). Our Operating Groups responded by increasing the amount of investment that they categorized as Initiatives (e.g. a 3 fold increase in 2005, and almost another 50% increase during 2006). Initially, the associated Organic Revenue growth was strong. Several of the Initiatives became very successful. Others languished, and many of the worst Initiatives were terminated before they consumed significant amounts of capital.” The last sentence is the hardest one to stomach. Terminating initiatives before they had consumed lots of capital, is the smart thing to do. It is the rational thing to do. However, I believe this is at the heart of why Constellation has struggled with organic growth over time. Now I’ll be the first to admit that Constellation’s strategy has been incredible, and my criticism is in no way taking that away from them. Frankly, they won’t care what I say. But, as a very astute colleague pointed out to me, this position of measuring all internal R&D and S&M initiatives, is almost self-fulfilling. At the time Leonard wasn’t concerned with the potential for lack of internal investment and organic growth. He even remarked as so: “I’m not yet worried about our declining investment in Initiatives because I believe that it will be self-correcting. As we make fewer investments in new Initiatives, I’m confident that our remaining Initiatives will be the pick of the litter, and that they are likely to generate better returns. That will, in turn, encourage the Operating Groups to increase their investment in Initiatives. This cycle will take a while to play out, so I do not expect to see increased new Initiative investment for several quarters or even years.” By 2013, he had changed his tune: “Organic growth is, to my mind, the toughest management challenge in a software company, but potentially the most rewarding. The feedback cycle is very long, so experience and wisdom accrete at painfully slow rates. We tracked their progress every quarter, and pretty much every quarter the forecast IRR's eroded. Even the best Initiatives took more time and more investment than anticipated. As the data came in, two things happened at the business unit level: we started doing a better job of managing Initiatives, and our RDSM spending decreased. Some of the adaptations made were obvious: we worked hard to keep the early burn-rate of Initiatives down until we had a proof of concept and market acceptance, sometimes even getting clients to pay for the early development; we triaged Initiatives earlier if our key assumptions proved wrong; and we created dedicated Initiative Champion positions so an Initiative was less likely to drag on with a low but perpetual burn rate under a part-time leader who didn’t feel ultimately responsible. But the most surprising adaptation, was that the number of new Initiatives plummeted. By the time we stopped centrally collecting Initiative IRR data in Q4 2010, our RDSM spending as a percent of Net Revenue had hit an all-time low.” So how could the most calculating, strategic software company of maybe all time struggle to produce attractive organic growth prospects? I’d argue two things - 1) Incentives and 2) Rationality. First, on incentives, the Operating Group managers are compensated on ROIC and net revenue growth. If you are a BU manager and could invest in your business vs. buy another company that has declining organic growth but is priced appropriately (i.e. cheaply) requiring minimal capital outlay, you achieve both objectives by buying lower organic growers or even decliners. It is almost similar to buying ads to fill a hole in churned revenue. As long as you keep pressing the advertising button, you will keep gathering customers. But when you stop, it will be painful and growth will stall out. If I’m a BU manager buying meh software companies that achieve good ROIC and I’m growing revenues because of my acquisitions, it just means I need to keep finding more acquisitions to achieve my growth hurdles. Over time this is a challenge, but it may be multiple years before I have a bad acquisition growth year. Clearly, the incentives are not aligned for organic growth. Connected to the first point, the “buy growth for low cash outlays” strategy is perfectly rational based on the incentives. The key to its rationality is the known vs. the unknown. In buying a small, niche VMS business - way more is known about the range of outcomes. If you compare this to an organic growth initiative, it is clear why again, you choose the acquisition path. Organic growth investments are like venture capital. If sizeable, they can have an outsized impact on business potential. However, the returns are unknown. Simple probability illustrates that a 90% chance of a 20% ROIC and a 10% chance of a 10% ROIC, yields a 19% ROIC. I’d argue however, that with organic initiatives, particularly large, complex organic initiatives, there is an almost un-estimable return. If we use Amazon Web Services as perhaps the greatest organic growth initiative ever produced we can see why. Here is a reasonably capital-intensive business outside the core of Amazon’s online retailing applications. Sure, you can claim that they were already using AWS internally to run their operations, so the lift was not as strong. But it is still far afield from bookselling. AWS as an investment could never happen inside of Constellation (besides it being horizontal software). What manager is going to tank their ROIC via a capital-intensive initiative for several years to realize an astronomical gain down the line? What manager is going to send back to Constellation HQ, that they found a business that has the potential for $85B in revenue and $20B in operating profit 15 years out? You may say, “Vertical markets are small, they can’t produce large outcomes.” Constellation started after Veeva, a $30B public company, and Appfolio, a $7.5B company. The crux of the problem is that it is impossible to measure via a spreadsheet, the unknown and unknowable expected returns of the best organic growth initiatives. As Zeckhauser has discussed, the probabilities and associated gains/losses tend to be severely mispriced in these unknown and unknowable situations. Clayton Christensen identified this exact problem through his work on disruptive innovation. He urged companies to focus on ideas, failure, and learning, noting that strategic and financial planning must be discovery-based rather than execution based. Maybe there were great initiatives within Constellation that never got launched because incentives and rationality stopped them in their tracks. It’s not that you should burn the boats and put all your money into the hot new thing, it’s that product creation and organic growth are inherently risky ventures, and a certain amount of expected loss can be necessary to find the real money-makers.
Larger deals. Leonard stopped writing annual letters, but broke the streak in 2021, when he penned a short note, outlining that the company would be pursuing more larger deals at lower IRRs and looking to develop a new circle of competence outside of VMS. I believe his words were chosen carefully to reflect Warren Buffett’s discussion of Circle of Competence and Thomas Watson Sr.’s (founder of IBM) quote: “I’m no genius. I’m smart in spots - but I stay around those spots.” While I appreciate the idea behind it, I’m less inclined to stay within my circle of competence. I’m young, curious, and foolish, and I think it would be a waste to pigeon-hole myself so early. After all, Warren had to learn about insurance, banking, beverages, etc and he didn’t let his not-knowing preclude him from studying. In justifying larger deals, Leonard cited Constellation’s scale and ability to invest more effectively than current shareholders. He also laid out the company’s edge: “Most of our competitors maximise financial leverage and flip their acquisitions within 3-7 years. CSI appreciates the nuances of the VMS sector. We allow tremendous autonomy to our business unit managers. We are permanent and supportive stakeholders in the businesses that we control, even if their ultimate objective is to eventually be a publicly listed company. CSI’s unique philosophy will not appeal to all sellers and management teams, but we hope it will resonate with some.” Since then Constellation has acquired Allscript’s hospital unit business in March 2022 for $700m in cash, completed a spin-merger of Lumine Group into larger company, WideOrbit, to create a publicly traded telecom advertising software provider, and is rumored to be looking at purchasing a subsidiary of Black Knight, which may have to be divested for its own transaction with ICE. These larger deals no doubt come with more complexity, but one large benefit is they sit within larger operating groups, and are shielded during what may be difficult transition periods for the businesses. It allows the businesses to operate more long-term and focus on providing value to end customers. As for deals outside of VMS, Mark Leonard commented on it during the 2022 earnings call: “I took a hard look at a thermal oil situation. I was looking at close to $1B investment, and it was tax advantaged. So it was a clever structure. It was a time when the sector could not get financing. And unfortunately, the oil prices ran away on me. So I was trying to be opportunistic in a sector that was incredibly beat up. So that is an example….So what are the characteristics there? Complexity. Where its a troubled situation with — circumstances and there’s a lot of complexity. I think we can compete better than the average investor, particularly when people are willing to take capital forever.” The remark on complexity reminded me of Baupost, the firm founded by legendary investor Seth Klarman, who famously bought claims on Lehman Brothers Europe following the 2008 bankruptcy. When you have hyper rational individuals, complexity is their friend.

Business Themes

Decentralized Operating Groups. Its safe to say that Mark Leonard is a BIG believer in decentralized operating groups. Constellation believes in pushing as much decision making authority as possible to the leaders of the various business units. The company operates six operating groups: Volaris, Harris, Topicus (now public), Jonas, Perseus, and Vela. Leonard mentioned the organizational structure in the context of organic growth: “When most of our current Operating Group Managers ran single BU’s, they had strong organic growth businesses. As those managers gave up their original BU management position to oversee a larger Group of BU’s (i.e. became Portfolio Managers), the organic growth of their original BU’s decreased and the profitability of those BU’s increased.” As an example of this dynamic, we can look at Vencora, a Fintech subsidiary of Volaris. Vencora is managed by a portfolio manager, itself a collection of Business Units (BUs) with their own leadership. The Operating Group leaders and Portfolio Managers are incentivized based on growth and ROIC. Furthermore, Constellation mandates that at least 25% (for some executives its 75%) of incentive compensation must be used to purchase shares in the company, on the open market. These shares cannot be sold for three years. This incentive system accomplishes three goals: It keeps broad alignment toward the success of Constellation as a whole, it avoids stock dilution, and it creates a system where employees continuously own more and more of the business. Acquisitions above $20M in revenue must be approved by the head office, who is constantly receiving cash from different subsidiaries and allocating to the highest value opportunities. At varying times, the company has instituted “Keep your capital” initiatives, particularly for the Volaris and Vela operating groups. As Leonard points out in the 2015 letter: “One of the nice side effects of the “keep your capital” restriction, is that while it usually drives down ROIC, it generates higher growth, which is the other factor in the bonus formula. Acquisitions also tend to create an attractive increase in base salaries as the team ends up managing more people, capital, BUs, etc. Currently, a couple of our Operating Groups are generating very high returns without deploying much capital and we are getting to the point that we’ll ask them to keep their capital if they don’t close acceptable acquisitions or pursue acceptable Initiatives shortly.” Because bonuses are paid on ROIC, if an operating group manager sends back a ton of cash to corporate and doesn’t do a lot of new acquisitions, then its ROIC is very high and bonuses will be high. However, because Volaris and Vela are so large, it does not benefit the Head Office to continuously receive these large dividend payments and then pay high bonuses. Head Office will have a mountain of cash with out a lot of easy opportunities to deploy it. Thus the Keep your Capital initiative tamps down bonuses (by tamping down ROIC) and forces the leaders of these businesses to search out productive ways to deploy capital. As a result, more internal growth initiatives are likely to be funded, when acquisitions remain scarce, thereby increasing organic growth. It also pushes BUs and Portfolio Managers to seek out acquisitions to use up some of the capital. Overall, the organizational structure gives extreme authority to individuals and operates with large and strong incentives toward M&A and ROIC.
Selling Constellation. We all know about the epic “what would have happened” deals. A few that come to mind, Oracle buying TikTok US, Microsoft buying Yahoo for $55B, Yahoo acquiring Facebook, Facebook acquiring Snapchat, AT&T acquiring T-Mobile for $39B, JetBlue/Spirt, Ryanair/Aer Lingus. There are tons. Would you believe that Constellation was up for sale at one point? On April 4th 2011, the Constellation board announced that it was considering alternatives for the company. The company was $630m of revenue and $116m of Adj. EBITDA, growing revenue 44% year over year. Today, Constellation is $8.4B of revenue, with $1.16B of FCFA2S, growing revenue at 27% year over year. At the time, Leonard lamented: “I’m proud of the company that our employees and shareholders have built, and will be more than a little sad if it is sold.” To me, this is a critically important non-event to investigate. It goes to show that any company can prematurely cap its compounding. Today, Constellation is perhaps the most revered software company with the most beloved, mysterious genius leader. Imagine if Constellation had been bought by Oracle or another large software company? Where would Mark Leonard be today? Would we have the behemoth that exists today? After the process was concluded with no sale, Leonard discussed the importance of managing one’s own stock price. “I used to maintain that if we concentrated on fundamentals, then our stock price would take care of itself. The events of the last year have forced me to re-think that contention. I'm coming around to the belief that if our stock price strays too far (either high or low) from intrinsic value, then the business may suffer: Too low, and we may end up with the barbarians at the gate; too high, and we may lose previously loyal shareholders and shareholder-employees to more attractive opportunities.” Many technology CEOs could learn from Leonard, preserving an optimistic tone when the company is struggling or the market is punishing the company, and a pessimistic tone when the company is massively over-achieving, like COVID.
Metrics. Leonard loves thinking about and building custom metrics. As he stated in the Q4’2007 letter, “Our favorite single metric for measuring our corporate performance is the sum of ROIC and Organic Net Revenue Growth (“ROIC+OGr”).” However, he is constantly tinkering and thinking about the best and most interesting measures. He generally focuses on three types of metrics: growth, profitability, and returns. For growth, his preferred measure is organic growth. He also believes net maintenance growth is correlated with the value of the business. “We believe that Net Maintenance Revenue is one of the best indicators of the intrinsic value of a software company and that the operating profitability of a low growth software business should correlate tightly to Net Maintenance Revenues.” I believe this correlation is driven by maintenance revenue’s high profitability and association with high EBITA levels (Operating income + amortization from intangibles). For profitability metrics, Leonard for a long time preferred Adj. Net Income (ANI) or EBITA. “ One of the areas where generally accepted accounting principles (“GAAP”) do a poor job of reflecting economic reality, is with goodwill and intangibles accounting. As managers we are at least partly to blame in that we tend to ignore these “expenses”, focusing on EBITA or EBITDA or “Adjusted” Net Income (which excludes Amortisation). The implicit assumption when you ignore Amortisation, is that the economic life of the asset is perpetual. In many instances (for our business) that assumption is correct.” He floated the idea of using free cash flow per share, but it suffers from volatility depending on working capital payments and doesn’t adjust for minority interest payments. Adj. Net Income does both of these things but doesn’t capture the actual cash into the business. In Q3’2019, Leonard adopted a new metric called Free Cash Flow Available to Shareholders (FCFA2S): “We calculate FCFA2S by taking net cash flow from operating activities per IFRS, subtracting the amounts that we spend on fixed assets and on servicing the capital we have sourced from other stakeholders (e.g. debt providers, lease providers, minority shareholders), and then adding interest and dividends earned on investments. The remaining FCFA2S is the uncommitted cashflow available to CSI's shareholders if we made no further acquisitions, nor repaid our other capital-providing stakeholders.” FCFA2S achieves a few happy mediums: 1) Similar to ANI, it is net of the cost of servicing capital (interest, dividends, lease payments) 2) It captures changes in working capital, while ANI does not 3) It reflects cash taxes as opposed to current taxes deducted from pre-tax income (this gets at a much more confusing discussion on deferred tax assets and the difference between book taxes and cash taxes) 4) When comparing FCFA2S to CFO, it tends to be closer than comparing ANI to reported net income. For return metrics, Leonard prefers ROIC (ANI/Average Invested Capital). In the 2015 letter, he laid out the challenge of this metric. First, ROIC can be infinity if a company grows large while reducing its working capital (common in software), effectively lowering the purchase price to zero. Infinity ROIC is a problem because bonuses are paid on ROIC. He contrasts ROIC with IRR but notes its drawbacks, that IRR does not indicate the hold period nor size of the investments. As is said at investing firms, “You can’t eat IRR.” In the 2017 letter, he discussed Incremental return on incremental invested capital ((ANI1 - ANI0)/(IC1-ICo)), but noted its volatility and challenge with handling share issuances / repurchases. Share issuances would increase IC, without an increase in ANI. When discussing high performance conglomerates (HPCs), he discusses EBITA Return (EBITA/Average Total Capital). He notes that: “ROIC is the return on the shareholders’ investment and EBITA Return is the return on all capital. In the former, financial leverage plays a role. In the latter only the operating efficiency with which all net assets are used is reflected, irrespective of whether those assets are financed with debt or shareholders’ investment.” This is similar to P/E vs. EV/EBITDA multiples, where P/E multiples should be used to value market capitalization (i.e. Price) while EV/EBITDA should be used to value the entirety of the business as it relates to debt and equityholders. Mark Leonard is a man of metrics, we will keep watching to see what he comes up with next! In this spirit, I will try to offer a metric for fast-growing software companies, where ROIC is effectively meaningless because negative working capital dynamics in software produce negative invested capital. Furthermore, faster growing companies generally spend ahead of growth and lose money so ANI, FCF, EBITA are all lower than they should be. If you believe the value of these businesses is closely related to revenue, you could use S&M efficiency, or net new ARR / S&M spend. While a helpful measure, many companies don’t disclose ARR. Furthermore, this doesn’t incorporate perhaps the most expensive investing cost, developing products. It also does not incorporate gross margins, which can vary between 50-90% for software companies. One metric you could use is incremental gross margin / (incremental S&M, R&D costs). Here the challenge would be the years it takes to develop products and GTM distribution. To get around this, you could use a cumulative number for R&D/S&M costs. You could also use future gross margin dollars and offset them, similar to the magic number. So our metric is 3 year + incremental gross margin / cumulative S&M and R&D costs. Not a great metric but it can’t hurt to try!
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April 2023 - Creativity Inc: Overcoming the Unseen Forces That Stand in the Way of True Inspriation by Ed Catmull and Amy Wallace

We continue our exploration of Disney’s history with this fascinating book on managing creativity by one of the best to ever do it, Ed Catmull!

Tech Themes

An Unlikely Start. When Pixar began, it did not set out to produce feature length films for children. In fact, it wasn’t even a movie studio. Pixar began as the computer division of George Lucas’s Industrial Light and Magic special effects studio. Following the success of Star Wars, Lucas sought to improve on his amazing special effects, by employing more digital computers. In 1979,Lucas hired Ed Catmull to lead the division, and begin building custom computers for special effects. As Catmull puts it; “Alvy’s team set out to design a highly specialized standalone computer that had the resolution and processing power to scan film, combine special effects images with, live action footage, and then record the final result back onto film. It took us roughly four years, but our engineers built just such a device, which we named Pixar Image Computer.” The name comes from a Pixer (a fake word) and Radar. In 1983, Catmull met a promising Disney Animator named John Lassester, who had just been fired by Disney after pitching his movie idea, Brave Little Toaster. Shortly after he joined Lucasfilm, the Pixar team set a goal to produce an animated short movie at the 1984 SIGGRAPH animation conference. Wally B. debuted and blew people away. Up until then, graphics was done by technology people, and almost never included storytellers and animators. As Walter Issacson pointed out in our January 2020 book, teams with diverse backgrounds, complementary styles, and visionary and operating capacity execute the best.
Exceptional Talent. Although Lasseter was a perfect fit at Pixar, gloom was on the horizon. In 1983, George Lucas divorced his then wife Marcia, which created financial challenges at Lucasfilm. He decided to sell Pixar, and courted buyers including Phillips, which wanted to use Pixar’s rendering capabilities for CT scans and MRIs, and General Motors which wanted to use its technology for modeling objects. Neither party wanted the team, and they definitely didn’t want to make animated feature films. Steve Jobs also took a look at the business, but couldn’t pull the trigger because of the immense pressure he was under at Apple (which ultimately led to his ousting). It wasn’t until almost 18 months later, and after founding NeXT, that Jobs was ready, and on January 3rd 1986, Jobs acquired Pixar for $5M. Pixar went about trying to sell their high-tech computer for $122,000 a piece, but couldn’t find many buyers (only 300 were sold). They continued making short videos and were even nominated for an Academy Award in 1987 for Luxo, Jr, a short film about a lamp. But the Company was losing tons of money, and by 1987, Jobs had sunk $54m into the company with little to show for it. The Company decided to pivot from selling computers, to making animated commercials for brands, but it didn’t produce enough cash flow to cover costs. Between 1987 and 1991, Jobs tried to sell Pixar three times: “When Microsoft offered $90 million for us he walked away. Steve wanted $120 million, and felt their offer was not just insulting but proof they weren’t worth of us. The same thing happened with Alias, the industrial and automotive design software company, and with Silicon Graphics…His reasoning was this: if Microsoft was willing to go to $90 million, then we mmust be worth hanging on to.” Jobs realized that Pixar had exceptional talent, and that it needed more time to achieve its vision. The combination of Lasseter, Catmull, and Jobs was truly unstoppable. These small acquisitions are reticent of IAC’s acquisition of College Humor, which came with a small video company called Vimeo. Sometimes these small acquisitions that are filled with creative talent can produce unbelievable results.
Unstable Ground. Its incredibly daunting to create something from nothing, whether its a company or a film. You feel unsure of yourself and your ideas, not knowing the right approach, wondering if your time is being used wisely. Managing in this environment requires: Frank talk, spirited debate, laughter, and love. To accomplish this list of positive tactics, Pixar created the Braintrust, a group of writers, directors, and creatives that could give early feedback to new films. The braintrust is made up of “People with a deep understanding of storytelling and, usually, people who have been through the process [of making a movie] themselves. The other important difference is the Braintrust has no authority, Directors do not have to listen to the feedback. The Braintrust has empathy for the Director. It knows: “[Mistakes] are an inevitable consequence of doing something new (and, as such, should be seen as valuable; without them, we’d have no originality.” As an example of this unstable ground, Catmull recalls the development of Monsters, Inc. Originally, Pete Docter (now CEO of Pixar), developed an idea that “revolved around a thirty-year-old man who was coping with cast of frightening characters that only he could see. His mom gives him a book with some drawings in it that he did when he was a kid. He doesn’t think anything of it, and he puts it on the shelf, and that night, monsters show up. And nobody else can see them. They follow him to his job, and on his dates, and it turns out these monsters are all the fears the he never dealt with as a kid.” Over a period of five years, Monsters Inc changed multiple times, but the ethos of “Monsters are real, and they scare kids for a living,” never changed. When approaching a creative project, things meander and wander, where they start is not normally where they end. Catmull believes: “Originality is fragile. Rather than trying to prevent all errors, we should assume, as is almost always the case, that our people’s intentions are good and that they want to solve problems. Give them responsibility, let the mistakes happen, and let people fix them.” New ideas are hard enough, you need to nurture and support them, whichever direction they go, to get to a high quality finished product.

Business Themes

Balance and Feeding the “Beast”. After Pixar was acquired by Disney, Catmull began hearing the phrase, “You’ve got to feed the Beast.” He was referring to “any large group that needs to be fed an uninterrupted diet of new material and resources in order to function. Following the success of the Lion King in 1994, The bureaucracy of Disney grew to the point that the process of making, marketing, and distributing films engulfed the creative process, leading to pressure for quick and fast success. You “feed the Beast, to occupy its time and attention, putting its talents to use. [But] success only creates more pressure to hurry up and succeed again. Which is why at too many companies, the schedule (that is, the need for product) drives the output, not the strength of the ideas at the front end.” In order to manage this all-consuming Beast, organizations must seek balance. You have to manage the goals of all parties involved, while giving time and energy to the best most creative ideas in the company. “The key is to view conflict as essential. A good manager must always be on the look for areas in which balance has been lost.” Its not as easy as it sounds to achieve balance, but experience is a helpful guide. It takes a constant focus and a subtle understanding of an organization’s psychology.
Pixar-Disney: A Love Hate Relationship. In January 2006, Disney acquired Pixar for $7.4B, a fairy-tale ending. But it wasn’t an easy beginning. After the incredible success of Toy Story, Pixar negotiated a five picture deal with Disney to handle its distribution, whereby Pixar would get an equal cut as Disney. Pixar delivered incredible films for Disney including: A Bug’s Life, Toy Story 2, Monsters Inc, and Finding Nemo. But all was not well in the partnership. Following a series of public slights at eachother, Steve Jobs and Michael Eisner essentially put the kaibosh on negotiations, both feeling they were the more important partner in any deal. With Cars and the Incredibles already in development, Disney and Pixar called off their partnership in 2004. This decision was the beginning of the end for Disney CEO, Michael Eisner, who resigned in the fall of 2005. Following his departure, Iger was named CEO, and set about repairing the broken relationship with Steve Jobs and Pixar. We have discussed the deal in length, but one of the subtle features was that Ed Catmull and John Lasseter would become head of Disney Animation, on top of Pixar. Disney animation was struggling. In the eyes of Circle 7 Studio Head Andrew Millstein, “Our filmmakers had lost their voices. It wasn’t that they had no desire to express themselves, but there was an imbalance of forces in the organization - not just within it, but between it and the rest of the corporation - that diminished the vailidity of teh creative voice. The balance was gone.” Wildly, the Pixar team notes that there were three sets of notes for a film: one from the development department, one from the head of the stuiod, and a third from Michael Eisner himself. This feedback was often conflicting and more “you must” then “you should think about.” When Catmull realized the challenge, they created a braintrust purposefully for Disney Animation, called the Story Trust. The first two meetings (for Meet the Robinsons, and American Dog - later Bolt) were unimpressive, and lacked the dynamism of true brain turst meetings. The Directors admitted they were afraid to give negative feedback to colleagues so publicly. Over time though the meetings took on more intensity, and a few years after the merger, Disney Animation produced its first successful movie in a while, Tangled. This was quickly followed by Wreck-it Ralph, and Frozen, and Disney Animation was back on track.
Notes Day. After many years of leading Pixar, Catmull realized that Pixar had become much larger, and: “More and more people had begun to feel that it was either not safe or not welcome to offer differing ideas.” The feeling of complacency was also manifesting in three real business problems. Production costs were rising, external economic forces were hitting the business, and a core tenant of the culture (good ideas can come from anywhere) was under attack. To remedy this onslaught of challenges, Pixar created Notes Day. The company created a digital electronic suggestion box where people could submit discussion topics that would help Pixar run more efficiently, with more innovation. They wittled down 4,000 suggesstions to 120 core topics. A handful of employees volunteered to be facilitators and were coached on how to keep meetings on track. The day started with an all-hands where John Lasseter admitted some personal shortcomings - he had been splitting time between Pixar and Disney and people didn’t like it and he frequently carried emotion from one meeting into the next, which confused employees and made employees more emotional. Then participants went to departmental meeting about efficiency, then broke into blocks of 90 minute sessions. At the end of each session - employees could fill out red forms for proposals, blue forms for brainstorms, yellow forms for best practices. The forms asked various questions about benefits to Pixar, how they could become a reality, why the idea was worth pursuing, and who should own the proposal. Notes Day was a cathartic day for employees, who shared feelings and emotions with eachother across functions and working groups. Catmull believes that Notes Day succeeded because there was a clear and focused goal (efficiency/candor), it was championed by senior management, and it was led from within, by individuals who volunteered to run sessions. The whole day mirrored the Kaizen process that was popularized by the Japanese auto-makers after W.E. Deming brought the practices to Japan. Although it was originally a World War II approach under the Training Within Industry job method, Kaizen was key to the Just-in-time manufacturing process used at Toyota. Feedback is critical to business success. Notes Day and Kaizen are great examples of the benefit of focused small improvements driven by passionate employees with great ideas.
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March 2023 - Mindset: The New Psychology of Success

This month we check out Satya Nadella’s favorite book - Mindset, by Carol Dweck. The book has become an international sensation and we find out why!

Tech Themes

Growth vs. Fixed Mindset. The book’s main argument is about the distinction between a growth mindset vs. a fixed mindset. A fixed mindset supposes that one’s abilities are fixed in nature - “I am smart because my parents were smart,” “I am good at sports without trying,” “I am good at tests because I just am.” People with fixed mindsets, who believe that people’s abilities largely can’t change, find themselves frequently feeling scared to make mistakes or be wrong. In contrast, a growth mindset supposes that people can drastically alter their abilities through challenge, hard work, perserverance, and the mental attitude that growth is attainable. Each person has some growth and some fixed mindset beliefs. Its important to understand that the fixed mindset is normally adopted because it benefits the person. As Dweck laments: “It told them who they were or who they wanted to be (a smart, talented child) and it told them how to be that (perform well). In this way it provided a formula for self-esteem and path to love and respect from others.” Often people can fall into the trap of results, whereby succeeding in something makes me good at it and failing makes me bad vs. praising and focusing on effort and improvement. For people that become hyperfocused on results, effort can be viewed as lowly. “If you are considered a genius, a talent, or a natural - then you have a lot to lose. Effort can reduce you. The idea of trying and still failing - of leaving yourself without any excuses - is the worst fear within the fixed mindset.” As someone who has put in significant effort into things like sports, only to lose in critical games, this sentence really resonated with me. Often you believe the effort should be rewarded with results, that is the dream described by coaches. But sometimes its not, and you have to wonder whether the effort is really worth it. However, this is a fixed mindset approach. The effort you put in is what establishes the long-term habit of success. Failures can occur from randomness. Failures could also signal that a change in approach is necessary, and often highlights an issue that had been papered over for one reason or another. The effort and the grind and the process are the fun part.
Managing and Teaching. One of the craziest things about mindsets is how easily they can be primed. Several studies discussed in the book place participants into a growth or fixed mindset with simple prompts. “Joseph Martocchio conducted a study of employees who were taking a short computing training course. Half of the employees were put into a fixed mindset. He told them it was all a matter of how much ability they possessed. The other half were put in a growth mindset. He told them that computer skills could be developed through practice. Those in the growth mindset gained considerable confidence in their computer skills as they learned, despite the many mistakes they inevitably made. But because of those mistakes, those with the fixed mindset actually lost confidence in their computer skills as they learned!” All day, every day, we are slipping in and out of different mindsets, often at the prompting of others. And frequently, these mindsets are little conversations going on in the back of our heads! Its important to try to recognize when you are slipping into a fixed mindset, and reframe the thought as a growth mindset one! Changing one’s perception of their own abilities is difficult, but that didn’t stop Marva Collins. “Collins took inner-city Chicago kids who had failed in the public schools and treated them like geniuses. Many of them had been labled ‘learning disabled’ or ‘emotionally disturbed.’..By June, they reached the middle of the fifth grade reader, studying Aristotle, Aesop, Tolstoy, Shakespeare along the way.” Collins set a strong upfront contract with her students: “None of you has ever failed. School may have failed yhou. Well, goodbye to failure, children. Welcome to success. You will read hard books in here and understand what you read. You will write every day…But you must help me to help you. If you don’t give anyhting, don’t expect anything. Success is not coming to you, you must come to it.” Collins raised the kids’ standard, while maintaining a compassionate and nurturing environment. This combination of challenge and nurture can produce wonderful growth. Its important that people don’t feel judged, but rather like someone is pushing them and trying to help them improve.
Motivation, Talent, and Mindset. Many people believe in naturals, indiviudals that simply rolled out of bed and became unbelievable athletes, leaders, business people, etc. They often miss the painstaking process of growth that led up to their eventual success. People often correlate talent with prior successes, forgetting the ways in which systems can produce mediocre talent from renowned systems. And frequently, society, parents, friends, and companions praise eachother for talent or success, rather than effort. In his book Malcolm Gladwell discusses the role that talent plays in an individual’s mindset. “Gladwell concludes that when people live in an environment that esteems them for their innate talent, they have grave difficult when their image is threatened. ‘They will not take the remedial course. They will not stand up to investors and the public and admit that they were wrong. They’d sooner lie.’” When we understand the basis of motivation, we can see why people feel threatened when they hold a fixed mindset about their “innate talent.” Self-determination theory speculates that motivation exists on a spectrum from amotivation (or complete lack of motivation) to extrinsic to intrinsic. There are several types of extrinsic motivation as you move along the spectrum to more internalized motivation: External regulation is motivation based on external rewards like compliance or money; Introjected motivation is based on approval from others and social acceptance; Identified motivation is based on consciously valuing the activity; and Integrated motivation is based on self-congruence, or I do this activity because this is the person I am. Lastly, we have full intrinsic motivation, where we pursue things solely because we enjoy doing that activity. For many high performing individuals, their passions seem to fluctuate between extrinsic motivators and intrinsic motivators. The reason we may feel threatened when we have a fixed mindset and our talent comes into question could stem from maintaining an identified or integrated motivation with an activity. For example, if you believe yourself to be a shrewd business person, and the motivation you feel to execute a business strategy comes from that belief that you are excellent, when you make a terrible decision you are faced with a view that sits in direct contrast to how you viewed yourself. This cognitive dissonance can cause severe depression. A growth mindset may reframe the terrible decision as a learning opportunity. Furthermore, a growth mindset may mean laughing at the decision, and getting excited about the challenge caused by it, placing more of the motivation on just executing the business strategy vs. the results of the strategy.

Business Themes

Lou Gerstner and IBM turnaround. IBM is currently facing challenges. Despite spinning off its services unit Kyndryl in November 2021, IBM’s stock remains at a negative return since June 2018. This isn’t the first time IBM’s business has gone off the rails. The 1970s and early 80s were so prosperous for IBM that their culture had gone sideways. A pervasive sense of entitlement filled the air. A 1990 Washington Post article discussed their challenges: “Since 1986, IBM has cut its work force three times. Its no-layoff policy (honored even in the Depression) seems vulnerable. So far all reductions have occurred through voluntary retirements. IBM has lagged in some new computer markets; workstations (souped-up personal computers) are an example. Profits have faltered. In 1988 they were nearly $800 million less than in 1984, despite a $13 billion rise in revenues. IBM's stock is trading around 100, down from the 1987 peak of 175 .” The company even came under antitrust investigation for monopolistic behavior (cough, sound familiar?). When all was lost, the board of directors turned to Lou Gerstner, who had successfully run the Travel Services division of American Express and led RJR Nabisco after KKR’s massive $25B buyout in 1989. Gerstner opened the channels of communication, disbanded the management committee, and tried to dismantle IBM’s hierarchical culture. He shifted bonus measures to broader measures like IBM’s overall performance, instead of narrow measures like a division’s EBITDA. The bonus structure change fostered teamwork across the company. By the time Gerstner stepped down in 2002, its market cap had risen from $29B to $168B. However, what’s excluded from the story is Gerstner’s tactics, he laid off 60,000 workers, including 35,000 in 1994. Gerstner was also handsomely rewarded for this turnaround, netting hundreds of millions in stock through option plans. Laying off workers and making money aren’t inherently bad, and Gerstner’s leadership is still commendable - but its important to note that it likely wasn’t just a mindset shift that led to his success at IBM.
Jack Welch - the Best or the Worst. Jack Welch is another executive lauded throughout the book. Long praised for his aggressive management style and focus on performance, Welch was considered an unquestionable genius when he was CEO of GE. Welch became CEO of GE in 1981 and embarked on a 20 year run filled with cost-cutting, layoffs, and countless acquisitions. Under Welch, GE made 600 acquisitions and pushed the company into every aspect of business, including owning TV station NBC and investment bank Kidder Peabody at one point. Kidder Peabody went through two famous trading scandals. In 1987, it was involved in Ivan Boesky’s insider trading scheme, and several years later (under GE’s ownership) it was the subject of another, more egregious trading scandal, whereby a trader placed fake trades and was paid bonuses based on fake results. Dweck uses this as a way to show Welch’s growth mindset: “There is a whole chapter titled ‘Too Full of Myself’ about the time he was on an acquisition roll and felt he could do no wrong. ‘The Kidder experience never left me’ It taught him that ‘there’s only a razor’s edge between self-confidence and hubris. This time hubris won and taught me a lesson I would never forget.” GE’s market value increased from $12B in 1981 to $410B in 2001. In 1999, Fortune named him manager of the century. He launched GE Capital, which would peak around 40% of its business: “But blue-chip G.E. had none of those burdens, which meant that, when it came to making money, Welch’s non-bank bank could put real banks to shame. He then used the proceeds from G.E. Capital to acquire hundreds of companies. In the warm glow of G.E.’s riches, Welch articulated a series of principles that captivated his peers. Fire nonperformers without regret. Shed any business that isn’t first or second in its market category. Your duty is always to enrich your shareholders.” But let’s dig into the not so bright side of Jack Welch. When he became CEO, Welch laid off hundreds of thousands of employees, taking GE’s total from 411,000 in 1980 to 299,000 at the end of 1985. He championed an Enron like approach of ranking employees and firing the bottom 10% every year. He was married three times, and had an extra-marital affair with a Harvard Business Review reporter, who eventually became his third wife. After Welch left GE, its stock fell precipitously, as it tried to unwind GE Capital and all of the other 600 acquisitions it had made during the conglomerate era of the 1980s. Welch’s retirement package was absolutely egregious: “After Welch left G.E., the details of his retirement package were made public. It included a pension of $7.4 million a year and a mountain of perks. He got the use of a company Boeing 737, at an estimated cost of $3.5 million a year. He got an apartment in Donald Trump’s 1 Central Park West, plus deals at the restaurant Jean-Georges downstairs, courtside seats at Knicks games, a subsidy for a car and driver, box seats at the Metropolitan Opera, discounts on diamond and jewelry settings, and on and on—all this for someone worth an estimated nine hundred million dollars. And then, finally, G.E. agreed to pay the monthly dues at the four golf clubs where he played.” If we can learn anything from Jack Welch about growth mindset, its that you can be both a fixed mindset person and a growth mindset person, judging and communicating.
Sports Mindset. Sports provide an excellent training ground to explore mindset. According to Dweck, growth mindset athletes tend to find success in doing their best, in learning and improving. They also find setbacks motivating and informative, digesting them as a wake-up call. Lastly, growth mindset athletes take more control of their process. Here Dweck discusses Tiger Wood’s Dad’s approach to toughening his son: “Tiger’s dad made sure to teach him how to manage his attention and his course strategy. Mr. Woods would make loud noises or throw things just as little Tiger was about to swing.” Woods would often envision a younger rival, pouring himself into learning shots” I have to give myself a reason to work so hard. He’s out there somewhere. He’s twelve.” While this psychological manipulation produced an amazing golfer, it also caused a lot of trauma. Tiger’s complicated relationship with his father and subsequent extra-marital affairs and DUIs have somewhat overshadowed his amazing golf achievements. Another reputationally poor example in the book is Lenny Dykstra. Dykstra, a man who has been charged with well over 25 misdemeanor and felony accounts and who personally filed for bankruptcy, is said to have had a growth mindset by Billy Beane, who claimed, “He had no concept of failure…And I was the opposite.” Beane eventually became GM of the Oakland Athletics, and focused their scouting and recruiting efforts on statistically sound and collegial players, rather than popular stars. Dykstra’s lack of failure concept was recently echoed by soccer star Kevin De Bruyne. “A lot of times when people make mistakes, they don't do it anymore. When I make a mistake, I try to do it twice more and if I make it twice more I'll do it again. I think in in one kind of way [its] learning where you go wrong and I think you understand more out of it if you make errors.” Kevin clearly displays a growth mindset and love for soccer.
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February 2023 - Anatomy of the Swipe by Ahmed Siddiqui

This month we dive back into the world of payments and take a refreshed look at how payments companies work.

Tech Themes

Authorization. How do credit card’s even work? What is on the magnetic stripe? It turns out that each stripe has an alternating set of tiny magnets on it that produce a magnetic field around the card. The card reader on a POS system is a solinoid; when the magnets swipe through the solinoid it creates a change in the magnetic field also known as magnetic flux. The POS processes the changes in current as its swiped through the Solinoid, and is able to understand the credit card via common card standards, created by ISO. The challenge that existed with the internet, is how to ensure safe transactions when you are paying someone you clearly don’t know. The card companies created something called the card verification value (CVV), an extra number directly intended NOT to be written anywhere except for the back of your credit card. CVV codes were originally created by an Equifax employee in the UK, and initially rolled out by NatWest bank, eventually expanding to Mastercard (1997), Amex (1999), and Visa (2001). However, the early internet still had a massive fraud problem, as Roelof Botha discussed about Paypal in his Tim Ferris podcast appearance. In addition, card authorization was still quite difficult in Europe, where you would frequently have to call to provide authentication for cross-border purchases. In 1993, Europay, Mastercard, and Visa formed EMVco, to add additional fraud protection to cards. They were subsequently joined by other key members including American Express, Discover, JCB International, China UnionPay. Europay eventually merged with Mastercard in 2002 prior to Mastercard’s IPO. EMVco creates a standard for EMV chips, which embed small integrated circuits that produce a single-use cryptographic key for a merchant to decrypt and authorize a transaction. It is also incredibly difficult to clone a chip card, whereas magnetic stripes are fairly easy to copy. The increase in fraud protection was so great that it caused a liability shift, whereby the merchant (rather than the issuer) could become liable for fraud if a EMV chip card was not used, and a swipe was used instead. The latest innovation in card security is 3D Secure 2, which “allows businesses and their payment provider to send more data elements on each transaction to the cardholder’s bank. This includes payment-specific data like the shipping address, as well as contextual data, such as the customer’s device ID or previous transaction history.” The 3D Secure 2 also improves the UX of its “challenge flow,” which is an instance when a frictionless authentication wasn’t possible, for whatever reason. The challenge flow forces the user to authenticate the transaction through their banking application of choice, which is much more secure than just approving every transaction the network sees. Every day payments become more at risk and more secure!
Zelle and banks Funded Payments. Similar to Visa and Mastercard, Zelle is a cash transfer system originally created by a consortium of banks. In 2011, Bank of America, JP Morgan, Wells Fargo, and several other banks built a Paypal competitor called clearXchange. The new company would charge financial institutions to use the service, with most banks assuming the charges on behalf of their consumers. At the time, Venmo was beginning to take off with consumers utilizing its simple Peer-to-peer payments service. In 2012, Braintree acquired Venmo for just $26m. The low purchase price was the result of a lack of coherent business model, given Venmo’s founding by college roommates who were looking to send money easily. Later, in 2013, Braintree was acquired by Paypal for $800m. Braintree is an acquirer processor and introduced a business model to Venmo, namely investing the float of customer funds held in the Venmo ecosystem. In 2016, clearXchange was acquired by another bank run service called Early Warning Service, which provides risk management services to many financial institutions. Early Warning was itself created in 1990 by Bank of America, BB&T, Capital One, JP Morgan, and Wells Fargo. Early Warning launched Zelle in 2017, utilizing clearXchange’s underlying technology. Zelle is now massive, processing over $1m in volume a minute, which is more than competitors Venmo and Cash App. Zelle’s most recent stats are mind-blowing: 2.3B payments with $629B in volume. Look at creation of zelle and other examples of banks creating new companies (like visa/mastercard)
Money for Nothing, SaaS for Free. A new brand of payments companies are popping up that seek to turn a traditional SaaS model on its head. Divvy, the spend management platform, gives its SaaS software away for free, instead monetizing just the payments processed through its product. Its quite wild to see a company build complex software just to give it away, right? This strategy has been copied many times over, as we talked about when discussing Netscape and Slack. Whether its open source or just free commercial software, the free-ness of it makes it attractive. However, if everyone is free, then you still have to compete on merit. Ramp, a competitor to Divvy, raised $750m at an $8.1B valuation in 2022, and processed over $5B in payment volume in 2021. Divvy was acquired by Bill.com in 2021 for $2.5B in a mix of cash and stock. At the time of acquisition Divvy was doing just over $100m of annualized revenue, and about $4B of TPV, suggesting a take rate of ~2.5%. Ramp allegedly did about $100m in annualized revenue in 2022. While Divvy was able to find a successful exit through a willing buyer (a buyer who’s stock has declined 65% from all time highs), I’m not sure Ramp will find an easy buyer at $8.1B, but it may find the public markets if it can market itself as a cost-saving, AI, finance play. I’m just not sure that you can build a really big business by only processing payments and giving away complex software for free. We will see in time!

Business Themes

Issuer, Issuer Processor, Acquirer, Acquirer Processor. The arc of an individual payment can be broken into its constituent parts. The Issuer is normally a bank that issues credit cards to its banking customers. A bank may use an issuer processor to manage a connection to the card networks (like Visa and Mastercard) and accept/decline transactions. Examples of issuer processors include Marqeta, TSYS, and Galileo. Global Payments and TSYS merged in 2019, in an absolutely massive $21.5B deal, after Fiserv acquired FirstData for $22B and Fidelity National Services acquired WorldPay for $34B. 2019 was definitely a banner year for payments mergers, but signs of strain are already happening, with FIS announcing they’d be spinning out WorldPay in 2023. Back to our transaction - the merchant will have a payment terminal of some sort, and will use an acquirer processor like Chase Paymentech, Tabapay, or Fiserv, that will also have a fast connection to the card networks to request approval for a transaction. Lastly, we have the acquiring bank, the merchant’s bank account. When we look back at these big deals, its clear that each player was trying to round out its processing capabilities - TSYS (issuer processor) with Global Payments (a merchant acquirer), Fiserv (merchant acquirer) with First Data (issuer processor), and FIS (issuer processor) with WorldPay (merchant acquirer). FIS, Fiserv, and Global Payments have struggled to win over investors over the last five years, following these big deals.
Chargebacks. When a consumer doesn’t want to pay for an item, it can request a chargeback. The reasons for a chargeback can be numerous and valid, including fraud, item not as described, duplicate transactions, and more. In the event of fraud, a cardholder would dispute the charge with their bank. The bank would freeze their card and file a chargeback with the card network (Visa as an example). Visa would send a provisional credit to the customers card and take the money back from the merchant, then it would send the chargeback request detail to the merchant. If the merchant doesn’t dispute the chargeback, it will be assessed a $25-35 chargeback fee by Visa. However, if it does dispute the chargeback, and correctly can identify that the card actually did purchase the goods, then the issuer, the bank that is “underwriting” credit to the consumer, can be put on the hook for the funds used for the purchase. I never knew that both the merchant and issuer can be on the hook for chargebacks, but not the network! Another way in which Visa and Mastercard make money through the ecosystem!
Marqeta’s confusion. For our first payments book, we took a look at several of the new players in the credit card ecosystem, including Marqeta, Adyen, and Stripe. Its been quite a two years! Marqeta went public in June 2021, valuing the company at $15B. Stripe raised additional funds at a $95B valuation, and Adyen’s valuation hit $98B! But oh how the times change! Just two years later, and Stripe’s valuation is back at $50B, including a massively dilutive $6.5B raise to pay for employee taxes in option conversion. Adyen’s valuation sits at $53B today, a close to 50% decline, despite growing EBITDA 16% to 728M in 2022.. Marqeta may have had the worst time of all, which is said because Ahmed Siddiqui, worked at Marqeta for a number of years. Marqeta’s stock fell 85%, its CEO/Founder left the company, its gross margins have compressed from high 40’s back to down to low 40s, and its main customer Block has become an even larger customer, now driving 77% of its revenue. Marqeta went from next generation issuer processor and Stripe wannabe to an outsourced custom development shop for Block. My guess is its actual reputation sits somewhere in between the two. Expectations for Marqeta have fallen off a cliff, and its market cap sits at a tiny $2.6B. I’m not sure Block would be an immediate acquirer, because the market for issuer processing is incredibly competitive and Block has had its own stock price troubles. A spun out WorldPay could make sense as an acquirer. Visa would have made sense as acquirer, because it owns about 2.5% of Marqeta and has for many years, but their recent acquisition of Pismo, believed to be a LATAM focused and better version of Marqeta. It’s unlikely Marqeta will exist long as a small solo issuer processor!
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January 2023 - Ride of a Lifetime by Bob Iger

This month we look at the recent history of Disney and its famous leader, Bob Iger.

Tech Themes

Creative Trust. Bob began his career at ABC Television, eventually working his way into ABC Sports and their newly acquired Entertainment and Sports Programming Network (ESPN). Their Bob came under the toutalege of Roone Arledge, a famous broadcast executive known for his commitment to storytelling, and his lack of compassion for sub-par work. Bob saw first hand how Roone would get close to the start of production, only to make several last minute tweaks to the overall program, sometimes throwing out all of the work that had been done to offer the audience a better program. Bob understood this creative process was messy and inefficient, but crucial to producing high quality programming. After ABC was acquired by Capital Cities, Tom Murphy and Dan Burke promoted Iger into a new role as head of ABC entertainment. Upon being handed a stack of 40 scripts on his first day, Bob wondered what he was even supposed to be looking for in a script. “I started to realize over time, though, that I’d internalized a lot by watching Roone tell stories all those years.” In his first season as president, Iger decided to go ahead with an off-putting, creepy drama directed by David Lynch called Twin Peaks. At one point, Murphy was so concerned about airing the show, that he told Bob, “You can’t air this. If we put it on television, it will kill our company’s reputation.” Iger pushed back, enthralled that the creative community love the risk the network was taking. A 1990 New York Times article spells out the risky show’s language: “The offending usage was in a Wall Street Journal story about Robert Iger, a bold television producer: ''Even if 'Twin Peaks' caves in, it has already won ABC new cache in Hollywood as the hands-off network, eager for ideas that are daring and different.'' Iger learned early, it pays to take big and bold risks, especially with the creative community.
Bob Iger and Steve Jobs. One of the first things Bob Iger did when he became CEO of Disney was call Steve Jobs. Disney’s prior CEO, Michael Eisner, had spent years arguing a battle for who had the better legal position in the Disney-Pixar distribution relationship. Pixar had succeeded everyone’s wildest dreams with films like Toy Story, A Bug’s Life, and Finding Nemo, but Disney wanted full control of Pixar’s characters and the rights to film sequels. Iger describeds the kerfuffle: “Steve’s animosity toward Disney was too deep-rooted. The rift that had opened between Steve and Michael [Eisner] was a clash between two strong-willed people whose companies’ fortunes were going in different directions. When Disney Animation began to slip even further, Steve became more haughty with Michael because he flet we needed him more, and Michael hated that Steve had the upper hand.” Iger, ever the flatterer discussed with Jobs how he loved his iPod and wanted to put Disney shows on future generations of the device. Steve responded by showing Iger the new iPhone prototype they were developing. They agreed on a deal and Iger strode on stage at the iPod video launch in 2005. In his first board meeting as official CEO, Iger proposed buying Pixar. The company was half owned by Steve Jobs, who had bought it from his friend and Star Wars creator George Lucas for a measly $5 million (plus several $20-30m equity checks). After receiving approval from the board to look at an acquisition, Iger called Jobs from his car phone: “I’ve been thinking about our respective futures, What do you think about the idea of Disney buying Pixar?” Jobs responded - “You know, that’s not the craziest idea in the world.” A few weeks later, the two sat in the Apple boardroom sketching a simple pros and cons list on the whiteboard. For all of the math and financial analysis that goes into an acquisition, its hilariously to envision Steve and Bob doing what anyone would do to analyze an acquisition. “Two hours later, the pros were meager and the cons were abundant, even if a few of them, in my estimation were quite petty…’A few solid pros are more powerful than dozens of cons,’ Steve said." The agreement was negotiated an in 2006, Disney acquired Pixar for a $7.4B equity value. Right before the merger was announced, Steve took Bob for a walk around Apple’s campus, and told him that his cancer had returned. “He told me the cancer was now in his liver and he talked about the odds of beating it. He was going to do whatever it took to be at his son Reed’s high school graduation, he said. When he told me that was four years away, I felt devestated. It was impossible to be having these two conversations - about Steve facing his impending death and about the deal we were supposed to be closing in minutes - at the same time.” The deal ultimately closed and Jobs became Disney’s largest shareholder and a board member at the company, during which Disney’s stock performed very well.
BamTECH. When Iger became CEO, he launched a three part plan to return Disney to the top of media and creativity. The plan was clear: “1) We needed to devote most of our time and capital to the creation of high quality branded content. 2) We needed to embrace technology to the fullest extent, first by using it to enable the creation of higher quality products, and then to reach more consumers in amore modern, more relevant ways. 3) We needed to become a truly global company.” If Pixar, Marvel, and Lucasfilm were an answer to part one, BAMTech was the answer to part two. Baseball Advanced Media Technologies was a company founded by Major League Baseball in 2000 to build out a digital radio streaming service for overseas listeners to the MLB playoffs. MLB Advanced Media was funded by a $1 million investment by each of its 30 teams for four consecutive years. Following a successful launch, BAMTech decided to try streaming live video of baseball games and launched MLB.tv, which soon became a major leader in streaming. Other leagues began to pay attention and soon the NHL had signed up BAMTech as its streaming partner, taking a 10% stake in the company. Soon ESPN, HBO, and the PGA Tour all signed on too. Disney used BAMTech as a back-end partner for the launch of its WatchESPN platform in 2010. So it was a natural extension for Iger, fresh off the massive success of the Pixar, Marvel, and Lucasfilm acquisitions, to try to buy the company. In 2015, BAMTech was officially spun out of the MLB, and in August 2016, Walt Disney acquired 33% of the company in August 2016 for $1B, valuing the streaming platform at $3B. In 2017, it upped its stake to 75% for another $1.58B, then in August 2021 it acquired the NHL’s 10% interest. Finally, it bought the remaining 15% interest from the MLB for $828m in October 2022. Amazing companies can come from anywhere. Based on some simple rough math, the MLB earned a 23% IRR on initial $120m investment from 2000 to 2022, a 28x return.

Business Themes

The Guide of Experience. Its clear that Bob Iger was molded into an incredible businessman through a series of experiences that almost no one could predict would create to such a compelling leader. Because Iger began in the TV industry at ABC, he began the habit of waking up absurdly early, a trait shared by many successful leaders. “To this day, I wake nearly every morning at four-fifteen, though now I do it for selfish reasons: to have time to think and read and exercise before the demands of the day take over.” After moving over to sports, Bob learned the importance of high quality from Roone Arledge, but he also developed one of his greatest traits, finding compromise among competing interests. “In 1979, the World Table Tennis Championships were being held in Pyongyang, North Korea. Roone called me into his office one day and said, ‘This is going to be interesting. Let’s cover it on Wide World of Sports.’ I thought he was joking. He surely knew it would be impossible to secure the rights to an event in North Korea. He wasn’t joking. I then embarked on a worldwide pursuit to secure the rights. After a few months of intense negotiations, we were on the eve of closing the deal when I received a call from someone on the Asian desk in the U.S. State Department. ‘Everything you are doing with them is illegal,’ he said. ‘You’re in violation of strict U.S. Sanctions against doing any business with North Korea…’ I eventually arrived at a workoaround that involved securing the rights not through the host country but through the World Table Tennis Federation. The North Korean government, though we were no longer paying them, still agreed to let us in, and we became the first U.S. media team to enter North Korea in decades - a historic moment in sports broadcasting.” When ABC was purchased by Capital Cities, Bob began his relationship with Dan Burke and Tom Murphy. Warren Buffett famously praised the pair: “Tom Murphy and [his long-time business partner] Dan Burke were probably the greatest two-person combination in management that the world has ever seen or maybe ever will see.” Iger learned tons about business, acquisitions, budgeting, and decentralized management from Tom and Dan. They also gave Iger numerous opportunities to prove himself and take risks, like the Twin Peaks launch. Later, when Cap Cities was acquired by Disney, Iger gained a front-row seat to Michael Eisner’s leadership style. Eisner was once regarded as one of the best CEOs in the world, but languished as the stress of managing a massive company caused him to become increasingly defensive and depressed. Despite sharing a complicated relationship, Iger learned a lot about managing Disney from Eisner, including what he didn’t want to do once he got the role. In hindsight, its no surprise that Iger became the leader he became, even though it wasn’t clear as it was unfolding.
A tale of M&A. Although Disney sticks in people’s minds as a family friendly media company, its sprawling empire has grown to include ABC, ESPN, Marvel, the Simpsons, Star Wars, Pixar, Marvel, Hotstar, National Geographic, Hulu, 20th Century Studios, X-Men, Deadpool, Fx, Disney World, Disney Cruise Line, and Disney+. This empire was constructed through many M&A deals. The first major M&A deal was the 1995 $19B Disney, Capital Cities merger, which was the second largest corporate takeover (to KKR’s RJR Nabisco LBO) ever. Warren Buffett became one of the largest shareholders of Disney, which he sold over the next few years, only to massively miss out on the growth of ESPN and eventually the content domination that Iger began. The deal took a while to digest, and vastly expanded Disney’s operations. Eisner’s legendarily poor hire of talent agent Michael Ovitz compounded pressures, and Eisner relied even more heavily on Disney’s Strategic Planning group to make corporate decisions. From 1995 to 2005, Disney’s stock increased only 25%, and Eisner was forced out in a brutal, public proxy battle. Once Iger took over, he collapsed the Strat Planning department under rising star Kevin Mayer, and began the series of acquisitions that marked his tenure. After Pixar, Iger turned to Marvel, which was stumbling along as a comic book and toy producer to a shrinking population of interested buyers. Despite its relatively small size, Marvel had a fascinating corporate history. In the late 80’s, Ron Perelman, billionaire businessman, bought Marvel for a mere $82m. However, after the comic book boom faded, Marvel fell into bankruptcy, and Icahn stepped in to buy Marvel’s distressed debt eventually becoming chairman of the board through a protracted legal process. At the last second, Ike Perlmutter and Avi Arad, managers of the largest susidiary of Marvel, Toy Biz, proposed a better offer to the bankruptcy court, and eventually wrestled control away from both Perelman and Icahn. By the time Disney came knocking in 2008, Marvel was beginning to produce its own films, after several successful Spider-Man and X-men films. While a lot of Disney executives believed Marvel was too edgy for Disney, Iger took a longer term view and bought the company for $4B, which has clearly paid off. Alongside the acquisition of Marvel, Disney invested about $100m for a 30% stake in a new streaming service created by NBC and News Corp called Hulu. Next, Iger turned to Lucasfilm, the maker of Star Wars. George Lucas was very reluctant to sell to Disney, and it took four and half years of convincing: “We went over and over the same ground - George saying he couldn’t just hand over his legacy, me saying we couldn’t buy it and not control it - and twice walked away from the table and called the deal off. (We walked the first time and George walked the second).” Eventually, Disney acquired Lucasfilm for $4.05B, another great content acquisition that has worked out well. While Iger is credited with these amazing acquisitions, his latest and biggest acquisition has raised the most questions for Disney. In 2017, Disney announced it would buy 20th Century Fox for $52B in stock, and the assumption of $13.7B of Fox’s net debt. However, the deal faced a long regulatory approval process, during which the US Justice Department ruled in favor of AT&T buying Time Warner. With what seemed like a favorable M&A environment, Comcast entered the fray, proposing an all cash bid at $35 a share or $64B. Disney upped its offer to $38 a share, half in cash and half in stock. Fox accepted Disney’s new bid (of $71B), and Disney closed the deal in March of 2019. While the deal did bring X-men, Deadpool, Fantastic Four, the Simpsons, Family Guy, it added $19B of debt to its balance sheet. In addition, Disney spent time selling Fox’s Sky ownership to Comcast, and the regional sports networks owned by Fox. These divestitures were necessary for the regulatory approval of the deal and netted Disney $24B ($15B from Sky and $9.6B from the sports networks). Covid through Disney for a loop, and its higher leverage from the Fox deal, caused the elimination of its dividend, and an obvious massive reduction to its parks business. Time will tell if the Fox Deal yields the same great results that Pixar, Marvel, and Lucasfilm produced - I wonder if this wasn’t too big for the integration risk entailed.
Walt Proxy. Disney has a rich history in not only animated characters but business characters as well. The company has repeatedly been subject to proxy battles. Iger’s first proxy battle began slowly then grew into a massive public boardroom debate. In 2002, Roy E. Disney and Stanley Gold, expressed their disappointment in Michael Eisner’s choices as CEO of Disney, sending a letter to the board demanding his removal. Eisner retailiated, “turning to the company’s governance guidlines regarding board member tenure, which stipulated that board members had to retire at age seventy-two. Rather than telling Roy himself, though, Michael had the chairman of the board’s nominating committee inform him that he would not be allowed to stand for reeelection and would be retired as of the next shareholders meeting in March 2004.” Roy began a public campaign called “Save Disney” where he called for Michael’s retirement and for him to rejoin the board. At the same time, Comcast launched a hostile bid for Disney. While Comcast would eventually find its content companion in NBC/Universal years later, this bid added heat to the situation. Comcast was unable to complete its bid, but the shareholder vote still turned out poorly for Eisner, with 43% of shareholders withholding support for him as CEO. He was promptly stripped of his chairman title, and in the fall of 2004, announced his resignation at the end of his contract in 2006. Fast forward to 2023, and Disney is back in the proxy battle world, this time facing up against Nelson Peltz, the famous activist investor. Under scrutiny are Disney’s acquisition of Fox, its exorbitant streaming losses, the cancellation of its dividend, the massive debt load it carries, and its large Netflix-competing content spend. The board recently announced that Iger would come back as CEO, despite clearly saying his time was over in the book. Iger’s successor, Bob Chapek, had a terrible run as Disney CEO, including shutting down the company, a public row with the State of Florida and Scarlett Johansson, and a centralization process that took control away from the creatives. I guess the Ride of a Lifetime is not over.
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December 2022 - We Are Legion (We Are Bob) by Dennis E. Taylor

This month we take a view into the future to see what a futuristic society full of AI, 5G, and easy space travel.

Tech Themes

Artificial General Intelligence. One of the most significant technological themes in the book is the development of AGI. Exhibiting artificial general intelligence would mean a computer could perform any task that humans could perform. While this is the ultimate vision of the AI hypetrain, there remains a big gap even between current iterations of GPT-4 and AGI. While Bob is able to seamlessly create VR experiences, recognize missles in flight, and upgrade himself, the world of computing today lacks the technology to fit all of these things into a sentient program. A 2019 article hypothesized by 2060 that we’d have full AGI. Other predictions suggest its 200 years away. It is still early days in the world of AGI, and there needs to be a lot more innovation before we get full AGI.
Programs Programming Programs. In the book, Taylor explores the concept of self-programmability when Bob discovers he can rewrite portions of his own code. Bob begins to set up virtual reality simulations for himself, complete with a cat, virtual baseball, and a butler. These VR “home” simulations offer a sense of normalcy that Bob dearly misses after reawakening as an AI. Later, Bob realizes that he is able to replicate his code. Code replication is similar to a type of AI called, Genetic Computing. In Genetic Computing, a program models the reproduction of a population based on a fitness measure and a mutation rate. When Bob replicates himself, he notices that each new Bob has a slightly different personality that all stem from his original personality. These personality changes make some replicants better suited for exploration vs. war vs. maintenance, which could be seen as their individual fitness functions. Genetic algorithms can be used to solve a whole host of machine learning and computing programs.
Technology and Emotion. Before he was killed in a car crash, Bob had sold his successful software company, netting him millions. With the extra money he paid the cryogenic service that would preserve his mind in the event something bad happened to him. After his death, Bob is awoken as an artificial intelligence. Similar to Ender’s Game, he finds himself being trained for an unknown objective, although he quickly understands its military related. Over time he becomes aware that other AI’s are going crazy and discovers that when left alone to process their fate as a war-faring AI, many become immensely depressed. Bob recognizes the immensity of time as a computer, with a clock that can work at the nano-second level. This theme raises important ethical questions about the implications of creating self-aware machines, notably the mental health consequences of inventing self-aware machines that experience the world differently than humans do.Therefore time feels extended beyond comprehension. After a while, Bob discovers an endocrine switch that overrides emotion. He’s curious about its function and switches it on, and immediately becomes overwhelmed with emotions: “You know that sinking feeling you get when you suddenly realize you’ve forgotten something important. Like a combination of fast elevator and urge to hurl. It hit me without any warning or buildup. Maybe it was the sudden release, maybe it was an accumulation of all the suppressed emotions, whatever, I wasn’t ready for the intensity. My thoughts swirled with all the thing that had been bugging me since I woke up…I mourned my lost life. I was still human in the ways that mattered.” Emotion and technology are often thought of as opposite ends of the spectrum, but they are more intertwined then people imagine.

Business Themes

Government and AI Future. Another business theme explored in the book is the power and influence of corporations. In the story, Bob's actions and the emergence of AI have a significant impact on the economy, politics, and society. This theme raises questions about the ethics of corporate power and the need for regulation to ensure that technology is used in ways that benefit society as a whole. For example, Bob is controlled by a religious government entity called FAITH, the Free American Independent Theocratic Hegemony, which is led by Christian Fundamentalists. While Taylor’s expression of a future whereby Christian Fundamentalists control the government is a commentary on an increasingly co-mingled church and state environment in the US, it also begs the question about control over AI. In China, the government has a front row seat and access to all potential AI innovations. In the US, a lot of these innovations are controlled by corporations, who will obviously work with the government but who do not necessarily need to sell to the government. At the same time, it would be difficult to envision how the American government would repossess or control all AI developments of underlying corporations. There is still a lot to be figured out between industries and government’s when it comes to AI innovation.
Space business. The book also explores the intersection of technology and business, specifically in the context of space exploration and colonization. Amazon's Kuiper and SpaceX's Starlink are two examples of companies that are driving innovation in this field. These satellite constellations have the potential to revolutionize industries such as agriculture, mining, and energy, by enabling real-time data analytics and remote control of machinery. The book touches on this theme with Bob's use of satellite constellations for communication and coordination in his efforts to explore and colonize new worlds. For example, the book explores the potential consequences of corporate control over space resources, highlighting the importance of ethical guidelines to ensure the equitable distribution of resources. Bob, who is a FAITH probe, fights China, the Australian Federation, and the Brazilian Empire over control of vast new space worlds. In the real world, people are beginning to question the value of these new constellation space businesses. A recent publication at Bernstein research noted: “Project Kuiper appears even more extreme as an investment area with $10B+ already committed. Perhaps there’s a lesson here from Google shutting Loon and stagnant Fiber and Fi businesses, that capital intensive low-margin utilities aren’t worth the effort regardless of how ‘cool’ the technology may be.” The durability of a real, sustainable business model has always been a question for Space focused businesses. As we learned from Carlota Perez’s Technology Revolutions and Financial Capital, the early establishers of infrastructure can either reap windfalls (railroads, steel) or face severe competition (telecom) which drives returns negative. I am skeptical that Kuiper or Starlink have a large enough market to create substantially large businesses that cover the cost of the capital expenditure involved in launching and maintaining the satellites. That being said, I think both organizations will probably learn a lot about space in the process, so should it ever become economically feasible, they would be ready to pounce (if they still exist).
3D Printing and The Food Question. Bob uses 3D printing technology to replicate himself into new versions with longer and larger appendages. “The area was a beehive of activity. Five version two HEAVEN vessels were under construction. One of which was a trade up from me. The new designs included a bigger reactor and drive, a rail gun, storage and launch facilities for busters, replicant systems with twice the capacity of version one, more room for storing roamers and mining drones, and more cargo capacity in general. The manufacturing systems cranked out parts as fast as the roamers could feed in the raw ore.” Bob creates many many roamers, which he uses in all sorts of ways, as drones, analyzers, and crafters. The plurality of use cases has always been the pitch for 3D computing, however, the businesses involved such as Desktop Metal or 3D Systems have struggeld to really hit mass consumer adoption. Today, it is still too hard for the average non AGI person to build things with a 3D printer, and most jobs are left to seasoned professionals. As the newly created Bob replicant’s peruse the universe for new worlds, original Bob sticks behind to help determine the fate of people on earth. One of the big challenges facing Bob is finding enough food for the world’s population while it is in transit to a new world. This situation is reminiscent of Wall-E, where the entire population of earth leaves after a nuclear attack. Food insecurity, or lacking access to quality food, is a global question, with estimates of over 345 million people facing high levels of food insecurity in 2023. In the US, about 10% of the population or 13.8 million households had low or very low food security. The question is complicated by the cost of sustainable farming, the role that farming and food play in greenhouse gas emissions, and how to use land with a growing population. Bob ulitmately decides to build a farm on a spaceship, which is reminiscent of the vertical farming craze that came through Ag-Tech around 2016-17. Three vertical farming businesses: Aerofarms, Kalera, and NL have gone bankrupt this week, after failing to find a financial sustainable business model. Its still early days in the world of alternative foods and new farming techniques, but we need to figure them out before the world population hits 10B in 2050.
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November 2022 - AI Superpowers by Kai Fu Lee

This month we dive into head of Sinovation Ventures, Kai Fu Lee’s book on the future of AI. I disagree with a lot of this book, and overall found it underwhelming. However, there are some interesting ideas that people can take with them into the future.

Tech Themes

Competitive Intensity in China. China's tech industry is fiercely competitive due to the sheer size of its market and the government's support for innovation. Local players like Baidu, Alibaba, and Tencent (BAT) have dominated the industry for years, but new players are emerging every day. This intense competition has created a dynamic tech ecosystem where companies constantly innovate and disrupt traditional industries. The race to dominate emerging technologies like AI, cloud computing, and 5G is particularly intense as these technologies have the potential to reshape entire industries. The markets are so competitive that entrepreneurs use almost absurd tactics to beat out rivals. In one instance, a new social network named Kaixin001 was gaining in popularity. The company was new and didn’t have enough cash to buy the Kaixin.com domain name, so its number one competitor Renren built an exact copy of Kaixin001’s website and bought the Kaixin.com domain name to launch the product. Within months their traffic plummeted and although they eventually won a lawsuit for unfair competition, the $60,000 reward was nothing compared to the loss of customers. Renren itself was a clone of Twitter, started by Wang Xing, the eventual founder of Meituan. In another instance, Tencent and Qihoo 360 got in a repeated blame-game fight, that eventually led to Qihoo Anti-Virus blocking the use of Tencent’s QQ and Tencent suing Qihoo in the first-ever Anti-Monopoly court case. The Groupon Clone Wars were a series of intense price wars between Chinese group buying sites like Meituan and Dianping. At one point, China had 6,000 group-buying sites. These sites copied Groupon's business model of offering discounts on local goods and services but adapted it for the Chinese market. The result was a hyper-competitive market where companies would aggressively discount their services to attract customers. This competition was good for consumers but ultimately unsustainable for the companies involved. Meituan and Dianping have merged to form a dominant force in China's online-to-offline (O2O) market. This merger directly opposed Alibaba’s wishes, and it massively funded competitor Ele.Me to compete. Today, Bytedance and Alibaba are suing Tencent and Meituan over monopolizing the food delivery industry. The competition in China is absolutely brutal - copying isn’t just allowed, it’s encouraged.
AI in Practice. Meituan Dianping and Bytedance are two of China's most successful tech companies. Meituan Dianping started as a group buying site for food and beverage deals but has since expanded into other verticals like travel and entertainment. Bytedance, on the other hand, is the company behind TikTok. Both companies have experienced explosive growth in recent years and are now among the most valuable startups in the world. Their success is a testament to China's ability to create homegrown tech giants that can compete on a global stage. Tiktok has built one of the best and most successful content recommendation algorithms ever. Alibaba's customer service chatbot, AliMe, uses natural language processing to understand and respond to customer queries. It can handle over 90% of customer inquiries without human intervention, allowing for quick and efficient responses. Another example is China Merchants Bank, which uses facial recognition technology to identify customers and provide personalized services. AI-powered recommendation systems are also being used by companies such as JD.com to suggest products based on customers' browsing and purchasing history. Furthermore, AI-powered voice assistants, like those developed by iFlytek and Baidu, are being used to help customers with tasks such as ordering food, booking hotels, and making payments. By leveraging AI technology, Chinese companies can provide customers with faster, more personalized, and more efficient service, ultimately leading to greater customer satisfaction and loyalty.
Chinese Government Investment in AI. China has become a hotbed for entrepreneurship in recent years, with startups popping up in every industry, from e-commerce to healthcare. The government has made it a priority to encourage innovation and entrepreneurship through initiatives like the "Made in China 2025" plan. The rise of angel investors and venture capitalists has also made it easier for entrepreneurs to raise funding. However, the market is still highly competitive, and success is far from guaranteed. The government has set ambitious targets for the industry, including the goal of making China the world's primary AI innovation center by 2030. China is expected to double its investment in AI to $27B by 2026, a simply astounding figure.

Business Themes

Mobile Payments and AI. Mobile payments have exploded in China, with platforms like Alipay and WeChat Pay becoming ubiquitous. China's large population and relatively low adoption of credit cards have made it an ideal market for mobile payments. Today, mobile payments are used for everything from paying for groceries to renting bikes. The convenience of mobile payments has also fueled e-commerce growth, as consumers can easily make purchases on their phones. The future of mobile payments in China looks bright, with experts predicting continued growth and innovation.
Four Types of AI. Lee categorizes AI into four types: internet AI, business AI, perception AI, and autonomous AI. Internet AI refers to algorithms that are used to power online services like search engines and recommendation systems. Business AI is used to optimize business processes and improve efficiency. Perception AI is used to analyze and understand visual and auditory data. Autonomous AI is used to power self-driving cars and other autonomous systems. Each type of AI has its own unique challenges and opportunities, and companies are investing heavily in each area to gain a competitive advantage.
The future of the Chip Industry. In December China announced an absolutely massive stimulus to the chip industry: “China is working on a more than 1 trillion yuan ($143 billion) support package for its semiconductor industry, three sources said, in a major step towards self sufficiency in chips and to counter U.S. moves aimed at slowing its technological advances.“ One of the big geopolitical challenges of today’s age is the role of TSMC in the chip industry. “‘TSMC is just absolutely critical,” says Peter Hanbury, a semiconductor specialist at the Bain & Co. consulting firm. “They basically control the most complicated part of the semiconductor ecosystem, and they’re a near monopoly at the bleeding edge.’” With TSMC located in Taiwan, the proximity to China can be concerning for the US, especially with China repeatedly ratcheting up the tensions. China’s domestic chip industry has not been able to reach the pinnacle of chip development, which is no easy feat. TSMC believes that excellence only comes from rigorous kaizen process and is not the result of larger investment dollars. Only time will tell who will win the chip wars.
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October 2022 - Amp it Up by Frank Slootman

This month we cover our third Frank Slootman book, Amp it Up! It covers Slootman’s overall philosophy with a specific focus on achieving significant growth at scale and how companies can push the boundary of their growth potential. Frank only wrote the book because Snowflake’s CMO encouraged him to do so.

Tech Themes

Expanding the TAM. One core idea that Slootman has used across both ServiceNow and Snowflake is the idea of expanding the TAM. By expanding the TAM, you lengthen your growth runway because there are more people who are capable of using your software. Slootman employed this strategy perfectly at ServiceNow. When on the IPO roadshow for the company, analysts at Gartner kept telling potential investors that ServiceNow had a small TAM of only $1.5B. An old short report of ServiceNow by Kerrisdale Capital highlights this confusion: “ The overall ITSM market size is only $1.5 billion, less than one-third of NOW's $4.7 billion market capitalization. Leading technology research firm Gartner estimates that the IT Service Management market opportunity is $1.5 billion, and is growing at a modest 7% per year. Furthermore, Gartner's research predicts that only 50% of IT organizations will move to SaaS by 2015, implying that the total market opportunity for NOW's ITSM business is less than $1 billion. Given emerging competition from other SaaS ITSM service providers, we believe that the company will have a difficult time exceeding 30% market share. At $207m of LTM revenue, NOW appears to already control 10% to 15% of the market. So even if NOW's market share rises to 30%, which we don't see happening until 2014 at the earliest, NOW's ITSM business should be generating less than $600m in revenue with limited additional growth opportunities. The result of the limited market size and increasing competition will be flattening growth over the next few years.” Kerrisdale was clearly incorrect. Market size estimates are now closer to $12-15B. Slootman and the team realized that to complete the full remediation of issues, more people in the organization needed to access ServiceNow’s tools and core ticketing system. They deliberately went function by function (network engineers, sys admins, database admins) and added specific functionality to enhance the user experience of these groups. One of these product enhancements was ServiceNow’s configuration management database or CMDB, which keeps a log of every device and its exact specifications to allow for faster triage of issues. Slootman has taken this approach to Snowflake, which started out by focusing on just the data warehousing workload but has since expanded into seven unique workloads: data warehouse, data engineering, data science, collaboration, data sharing, unistore, and cybersecurity. These workloads now bring in more people to the Snowflake platform: database administrators, data engineers, analytics engineers, data analysts, data scientists, and cybersecurity analysts. Each new set of tools added, enhances the overall value of the platform and the stickiness of the solution within the organization. This is a great roadmap for how to keep growth elevated in horizontal markets.
Strategy vs. Execution. “Culture eats strategy for breakfast.” Peter Drucker, a famous consultant, and author of the Concept of the Corporation, believed that culture was far more important than strategy. Slootman agrees and even takes it one step further: “Execution has to be your number one goal. Strategy can’t be mastered until you can execute. Great execution is rarer than great strategy.” Slootman actually disagrees with Drucker on the management by objectives framework, “Another source of misalignment is management by objectives, which I have eliminated at every company i’ve joined in the last twenty years. MBOs cause employees to act as if they are running their own show, because they get compensated on their personal metrics, it is next to impossible to pull them off projects. They will be negotiating with you for relief. That is not alignment, that is every man for himself. If you need MBOs to get people to do their jobs, you may have the wrong people, the wrong managers, or both.” In Slootman’s eyes, management by objectives, which sets objectives for an entire organization that are translated into individual goals, ends up being abused by managers. Managers may rely on the objectives solely, and discount the leadership and creative thought necessary to succeed beyond an objective. “A person can do an excellent job according to objective measurement standards, but can fail miserably as a partner, subordinate, superior, or colleague. It is common for people not to be promoted for personal reasons than because of technical inadequacies.” For Slootman, superior execution comes from good judgment, and good judgment comes from bad judgment. Bad judgment is only made clear through experience, which can be the best teacher in his eyes. “New managers have to learn from and through their management chain. Organizations cannot scale and mature around inexperienced management staff.” At Data Domain, Slootman’s team finally started seeing success when they found the right leader for their contract manufacturing organization; at ServiceNow, when they found the right leader for cloud infrastructure; at Snowflake, when they found the right leader for scaling. “The organization needs innovation and discipline, or else the place will simply implode on itself. The common mistake is to rely on our innovators for discipline.” 5 dysfunctions of a team. Why execution is harder than strategy. But need to Prepare your next strategy early so you are ready when you get there.
Recruiting Talent. Slootman urges leaders to recruit drivers, not passengers. “Passengers are people who don't mind simply being carried along by the company's momentum, offering little or no input, seemingly not caring much about the direction chosen by management. They are often pleasant, get along with everyone, attend meetings promptly, and generally do not stand out as troublemakers. They are often accepted into the fabric of the organization and stay there for many years. The problem is that while passengers can often diagnose and articulate a problem quite well, they have no investment in solving it. They don't do the heavy lifting. Drivers, on the other hand, get their satisfaction from making things happen, not blending in with the furniture. They feel a strong sense of ownership for their projects and teams and demand high standards from both themselves and others. They exude energy, urgency, ambition, even boldness. Faced with a challenge, they usually say, ‘Why not’ rather than ‘That’s impossible.’ These qualities make drivers massively valuable. Finding, recruiting, rewarding, and retaining them should be among your top priorities.” What I find most interesting about this philosophy is that most jobs train people to be passengers. Most CEOs prefer the calm and non-trouble making attitude of passengers over the outspokenness and aggression that sometimes comes with drivers. So what do you do when you find passengers? Its simple - get them off the bus. Although it can be intense, you need to execute by removing people first, getting the right people in, and then getting the right people in the right spots. We talked about this analogy in the Jim Collins book Good to Great. “At a struggling company, you need to change things fast by switching out people whose skills no longer fit the mission or never really did in the first place. The other advantage of moving fast is that everyone who stays on the bus will know that you are dead serious about high standards. The good ones will be energized by those standards.” The challenge with moving quickly is finding the right balance for what the organization can absorb at any given time. Moving too quickly when the organization is not ready, or moving too quickly when the plan hasn’t been set can lead to drastic consequences.

Business Themes

Turnarounds as a Training Ground. Famous football coach Bill Walsh joined the San Francisco 49ers after they were the last placed team in the NFL with a 2-14 record. The next season, Walsh’s first, the 49ers repeated the performance - 2-14 again. Walsh at one point broke down on a flight home from a crushing defeat against Miami. 16 months later, he was Super Bowl champion. Turnarounds provide an unbelievably difficult training ground for young executives. It is sink or swim, it is kill or be killed. As discussed in our last book, Bill McDermott took over the struggling SAP North America division before righting the ship and accelerating SAP to growth. Frank Slootman began his managerial career in similar situations. After stints at Burroughs Corporation in corporate planning and Comshare in product management, Frank joined Compuware as head of non-mainframe Product Management. While there, Compuware acquired the dutch company, uniface, as we touched on in the Tape Sucks book. “I jumped at the opportunity return to Amsterdam to take on the entire operation, which seemed in disarray. Colleagues warned me not to go because the place could not be saved, and they worried I’d go down with the ship. Compuware had bought uniface toward the end of its viable product software. But by now, my career had been about taking on what seemed like long odds, jobs nobody else would touch with a 10 foot pole. It was the only avenue open to me anyway and it didn’t matter how hairy these deals were. As a young person, you easily overestimate your capabilities, this is when I started learning what happens when you step into the wrong elevators. We did manage to stabilize uniface. That became a formative career experience in my mid-30s. I’d never had multiple numerous large, mission-critical customers before and hundreds of employees in my charge. I also started to develop an eye for talent which became a cornerstone of my management focus going forward.” Next, Slootman jumped to Ecosystems, a Compuware subsidiary based in silicon valley. He stabilized the struggling company, but they kept losing talent because mid-western Compuware wasn’t able to retain silicon valley employees. He then joined Borland as SVP of product operations, which had also fallen on hard times. They resurrected the brand and the business. Even by 40 years old, he was taking on problem children, and he kept getting offered CEO jobs at companies that were elevators to nowhere. Slootman interviewed over and over for CEO roles but was passed on because “you’ve never run sales.” He later commented on being passed over: “I led from the front and sold shoulder to shoulder with sales. These rejections left me with an unfavorable opinion of many venture capitalists who couldn’t recognize talent if it smacked them in the face.” Turnarounds, especially those inside big companies offer management challenges that most people don’t get to experience until its too late. For Slootman and McDermott, these were the right opportunities for their personalities and approaches at the right time of their career.
Frank doesn’t believe in a Customer Success department. At Snowflake, there is no customer success department. In Slootman’s eyes: “They were happy to follow the trend set up by other companies like ours. But not me. I pulled the plug on these customer success departments in both companies, reassigning the staff back to the departments where their expertise fit best. Here’s why I was so opposed - if you have a customer success department that gives everyone else an incentive to stop worrying about how well our customers are thriving with our products and services. That sets up a disconnect that can create major problems down the road. People can become more focused on hitting the narrow goals of their silo rather than the broader and more important goal of customer satisfaction, which ultimately drives customer retention, word of mouth, profitability, and the long-term survival of the whole company. For instance, at ServiceNow, some of the customer success people grew quite dominant in the interaction with the customer and coordinated all the resources of the company for the customer’s benefit, including technical support, professional services, and even engineering. This had the effect that other departments sat back, became more passive, and felt less ownership of customer success. Customer success is the business of the entire company, not merely one department.” While this approach may work for Snowflake, it is not the norm in the SaaS world. In fact, there are entire companies like Gainsight, Totango, and ChurnZero, that help companies accelerate their Customer Success motion. Openview Venture Partners views customer success as critical for an effective product-led growth sales motion. Sales and Customer Success are important ways of generating product feedback from customers, but organizations need to make sure not to overwhelm product and engineering priorities. Often product teams don’t invest enough time in understanding the sales organization and the sales team views the product team as simply delivering on features to close deals. Leadership is necessary to help set priorities and collaboration across these departments.
5 steps to Amp it Up. Slootman outlines a five-step process for business leaders to accelerate growth and transform their organizations. The first step is to raise your standards and set ambitious goals for your company. This is followed by aligning your people and culture to support your vision, which requires careful attention to hiring, training, and communication. The third step is to sharpen your focus and prioritize the most critical areas of your business for growth. Once you have a clear focus, the fourth step is to pick up the pace and execute with speed and urgency. Finally, the fifth step is to transform your strategy by continually adapting to changes in the market and taking bold actions to stay ahead of the competition. By following these five steps, Slootman believes that business leaders can create a culture of high performance and achieve extraordinary results. Underpinning everything, is a culture of trust. Ultimately high performance cultures can be challenging and Slootman had times where former founders like Fred Luddy disagreed with his decisions. But as Slootman puts it: “In the long run, success trumps popularity. In my early days at several companies, founders openly regretted my hiring and openly complained to the board behind my back. But when companies succeed massively, as all of our companies have, founders will eventually get over it. Yes, its nice if they love you, but you can’t let yourself get rattled if they don’t. Your mission is to win, not to achieve popularity.”

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September 2022 - Winners Dream by Bill McDermott with Joanne Gordon

This month we hear about Bill McDermott’s meteoric rise to the CEO job at SAP and his philosophy around management. I must also acknowledge the incredible and underappreciated role that Julie McDermott and Bill’s family plays in this book. Bill moved his family from NYC to Puerto Rico to Chicago to Rochester to Connecticut to California to Philadelphia over the course of his 25-year career. Sometimes with multiple moves rather quickly. The selflessness they displayed is unfathomable.

Tech Themes

Growing License Revenue at SAP. When Bill McDermott got to SAP North America, he quickly realized they were behind the game. The firm had enjoyed relatively unmatched success in its early years but was now coming into competition with one of Bill’s former employers - Siebel Systems. He saw what he viewed as lackluster standards - people were late to meetings, lacked professionalism, and moved painfully slowly on new action plans. McDermott created a new strategy around a $3B revenue target, and recruited the company’s top managers to share the plan in mini-meetings across every division. After providing the new strategy, he focused on value engineering, a way of demonstrating the ROI from implementing a company’s software. He instituted a weekly Top 20 Call, where the head of sales detailed the top 20 deals in progress, and Bill unleashed his sales intensity in helping people close deals. “What’s the business case? Have we presented it to the CEO? When is the next meeting? What, you just found out the company can’t sign because its purchasing director is on vacation? What’s your plan to backfill the loss? If someone didn’t know his next move, he wasn’t doing his job.” One of McDermott’s super-powers is maintaining a big vision while being able to slip into the micro-managing intensity of Andy Grove’s Only the Paranoid Survive and Ben Horowitz’s War-time CEO. 85% of C-Suite employees left, McDermott recruited 100 new sales employees, and in 2005, SAP America delivered $3.2B of revenue.
Reinvention. McDermott is unafraid to go in new directions and take on new challenges. He had earned his stripes by taking over challenged business units in Xerox, first Puerto Rico, then Chicago, and then Xerox Business Services, their outsourcing division. Xerox at the time was suffering from a classic Innovator’s Dilemma - the XBS division was growing quickly but resulted in lower profit margins, so was not getting the love and admiration it deserved. “Instead of worrying about the value of my retirement account, I was interested in growing the business. Rather than ignoring the changing market, we should have been pouncing on it…Many people thought I was crazy to join the junior varsity team. XBS represented only 5 percent of Xerox’s overall revenues. Others even tried to block my transfer to XBS.” McDermott believed in the power of pageantry and held a massive, blow-out sales conference in San Antonio, complete with fake politicians and news style interview booths. McDermott had set a $4B revenue target for XBS and he missed the target. XBS revenue’s grew from 900m of revenue to $2B in 1997, $2.7B in 1998, $3.4B in 1999, and $3.8B in 2000, just missing the $4B revenue target by 2000. “Was I upset that we fell shy of our $4B bull’s-eye? Not one bit. The point of setting audacious goals was that we could almost hit them and still accomplish something amazing. Had we never strived so high, we never would have hit as high as we did.”
Internet Bubble Comes Calling. Bill is human, like all of us, and so when the internet bubble started to take off, and he found himself on the sidelines managing an outsourcing business at struggling Xerox, he started to get the itch to get into the fray. A young startup called Techies.com had reached out asking if Bill would be their CEO. Bill considered it an interesting proposition - everything was going up and to the right and Techies could IPO as soon as next year. Techies.com was an online website for tech companies to post about job openings. After meeting everyone and interviewing for the job of CEO, Bill decides he can’t do it. “ The only thing about your company that really interests me is the money, and that’s the wrong reason to work for anyone.” Bill did get whisked away though, by another IT firm - Gartner. Bill had left Xerox for a whole 2 weeks in 1995 and joined Gartner at the urging of former Xerox executive, Follett Carter. McDermott joined Gartner in 2000, serving as President while Michael Fleisher served as CEO. He felt it was off from the first couple weeks on the job. “I saw it in the jeans and tieless shirts that even senior executives wore Mondays through Fridays. I felt it in Gartner’s small-company, New Economy culture, which shocked my corporate sensibilities.” Matters were maid worse when Julie McDermott was diagnosed with Breast Cancer. Things were tough for the year Bill was at Gartner, and he decided to move on to Siebel Systems where he worked with tech legend, Tom Siebel, founder of Siebel Systems and C3.AI. Bill would only last a year at Siebel too, burnt out after working tirelessly in the months following 9/11. In hindsight, each of these smaller steps into executive roles broadened Bill’s knowledge of the technology evolution and CRM space specifically. These would be the foundation for his job offer from SAP America in 2004.

Business Themes

Setting Ambitious Goals. Bill is no stranger to big roles and he absolutely relishes the spotlight. He has a smooth, calming, excited voice that shines through every word in the book. He is a big vision guy, but unafraid to get tactical in areas he knows well like sales. Having worked his way up from a rookie salesman at 22 to a district manager at Xerox, McDermott always took a similar approach to fixing broken organizations. When he got to his district manager role in Puerto Rico, the worst performing district in Xerox, he made it clear that things were going to change. He wanted to take Puerto Rico from the worst performing division to the best performing division in one year. He set out by asking the sales managers a simple question: “What do you need?” He slowly identified the issues holding the division back (a lack of investment, consistent expense cuts, and poor goal setting) and he fixed them. Puerto Rico became the number one sales group in Xerox. This extreme goal setting shows up multiple times in McDermott’s career. When he became head of Xerox’s outsourcing XBS division he set a $4B revenue goal. “Three billion dollars in revenue by 2000 was a more realistic goal yet still a dream target. So why not tell everyone $3B, Bill? Because my hurdle - getting my people ecstatic about selling outsourcing - was so high that I need to get everyone’s mind to a place where the dream soeemed so impossible that it was exciting to pursue. For more than a decade now, I’d watched teams rise to the expectations set for them. The more daring the target, the higher people rose.” When he got to SAP America, he proclaimed they’d be a $3B revenue business by 2005, after years of lackluster growth, “In the next three years, we are going to increase our revenue by one billion dollars. Since 1999, SAP America’s revenue had barely grown $100m, in total.” After a major operational overhaul, they achieved his goal. When he got to ServiceNow, he similarly announced a goal of $10B of annual revenue. Time will tell if he hits the goal.
Big software M&A - Does it work? Bill McDermott was on the way to Hawaii when he got the call from SAP’s board about becoming Co-CEO of SAP. After the shock wore off, he quickly accepted the job, excited to lead the whole organization after he had successfully turned around SAP North America. Bill initially shared the CEO role with Jim Hagamann Snabe, a German engineer that would lead the product and engineering side of the business while Bill focused on commercial efforts. In 2014, Bill was named sole CEO, a new development for the traditional SAP that normally opted for a co-CEO model. Reflecting on it years later, Mcdermott commented in a Duke university visit in 2016, “Well, you know, when we were co-CEOs in 2010, it's what the company needed then. As you know, we were coming off the financial crisis of 2008. 2009 was a relatively slow recovery for the world, and SAP made a CEO change. And it was really important to have one office of the CEO with two friends, that really wanted to make a difference. And a lot of things needed to be done to build the company, build a strategy, do some major M&A moves, and get the company set up for growth again. And once that was done, then it became necessary to build on the vision but make much quicker decisions, move at a pace that was even beyond the pace we were moving at, which was pretty fast. And at that point, SAP needed that person that could make the call and be very, very decisive. And fortunately, things seem to be going pretty well.” McDermott launched an aggressive M&A campaign, spending $35B in acquisitions from 2010-2020. The acquisitions added about $3.4B of revenue to the company. These acquisitions were in all sorts of different areas but focused on SAP’s core areas including ERP, HCM, and Database technologies. I believe these acquisitions did two things simultaneously for SAP. Sirst it helped push a historically mainframe driven technology company into the cloud. Second, it broadened the capabilities of their core ERP offering while extending SAP into global markets, particularly strengthening its US position against ERP competitor Oracle, which had its own ERP and HCM applications. While these acquisitions worked for a time, the company is still fighting its license/maintenance past, and trying to move more aggressively to the cloud. The positive way to view these deals is Bill grew the organization, its capabilities, and its reach while using modest amounts of leverage and growing the company’s revenue and EPS. The negative way to view it is Bill went on a shopping spree of random technologies that were never fully integrated, and today saddle the company with enormous tech debt, little flexibility, and sub-par growth.
The Journey: Ithaca to CEO. Bill is a strong proponent of enjoying one’s career journey over its destination. As a night MBA student at Kellogg, he learned of the C.P Cavafy poem, Ithaca, which reads: “Keep Ithaka always in your mind. Arriving there is what you’re destined for. But don’t hurry the journey at all. Better if it lasts for years, so you’re old by the time you reach the island, wealthy with all you’ve gained on the way, not expecting Ithaka to make you rich. Ithaka gave you the marvelous journey. Without her you wouldn't have set out. She has nothing left to give you now. And if you find her poor, Ithaka won’t have fooled you. Wise as you will have become, so full of experience, you’ll have understood by then what these Ithakas mean.” As he contemplated moving on from Xerox, and pushing away his dream of becoming CEO, he came back to this poem, using it as a base before writing out his core beliefs and goals. “ My personal goals included having quality time with my family; to love Julie with the enthusiasm and compassion of our wedding day; to help my son (and eventually his sibling) grow into a healthy, happy, well-adjusted adult; to love my parents and my brother and sister, always remembering my roots, and to live with passion every day. Next, I listed my career aspirations: 1. To be a winner. 2. To lead others to the doorstep of their dreams. 3. To manage a career and not the other way around. 4. To never confuse that which is most important with that which is not. 5. To earn a living commensurate with my talent, but not be ruled by the shallow shadows of money. 6. To be the ruler of my own destiny, not to slave for what someone else wants my destiny to be - in control.” Ten years later, when he was considering moving on from Siebel Systems, Bill re-wrote his goals again and realized that he wanted to be in control of his own destiny. “ I wanted my freedom back. I was ready to be a CEO.”

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August 2022 - Invention: A Life by James Dyson

This month we dive into an innovation classic by examining the life of of James Dyson and the creation of his world famous vacuum cleaner.

Tech Themes

IP. James Dyson believes that entrepreneurs should always retain their creations. He is a staunch advocate for patent protection and rights. When we look back at the history of Dyson, we can understand why. As a young entrepreneur, Dyson created the ball-barrow, the first wheelbarrow that used a single round ball instead of two wheels on each leg. With improved design, the product performed well; however, the board forced Dyson out of his company over a disagreement on managing the company's financial situation. Even worse, the company owned the ball barrow's patent, so James walked away with nothing but hard-earned experience and frustration. He set out to make his cyclonic vacuum and famously succeeded after 5,127 prototypes. Dyson then set out to partner with distribution channels and found Amway, a Michigan-based electronics company. In 1984, the two companies agreed on a partnership, and Dyson sent over specifications, design prototypes, and core company IP. However, shortly after that, they canceled the agreement and sued Dyson for fraud. Even worse, Amway launched an exact copy of Dyson's DC01 and was trying to compete against Dyson in the US. Dyson shot back and sued Amway. Over the next seven years, Dyson would struggle through the US court system, ultimately winning his legal case against Amway. "When you've developed a new technology, or created a radically different product, have beaten the skeptics, established awareness, and battled to create a market for it, to discover a similar product from the company that canceled the licensing agreement is sickening as if you've been punched in the solar plexus. You feel outraged by the personal theft and helpless." Dyson eventually settled with Amway in 1991, recouping all of his legal costs and gaining control of his IP.
Testing. Dyson loves testing new products. Every test (and every failure) tells you about your product and how it can be improved. He would often spend hours in his garage making minor adjustments to the cyclonic vacuum, hoping the next time would yield positive results. Over time, Dyson has adapted its testing procedures. While most companies employ some basic tests for defects, Dyson wants its products to fail the tests. Head of Testing Marco Li explains: "Everything we test will fail, in one respect, because the way we test our products we want to make sure it fails. That's the only way we can be sure we know what the limits of our technology are and make sure that what we say on the box isn't the best, but the worst-case scenario." Paradoxically, Dyson finds joy in failing: "It's a never-ending process that is enormously rewarding, and endlessly frustrating. There are countless times an inventor can give up on an idea. By the time I made my 15th prototype, my third child was born. By 2,627, my wife and I were really counting our pennies. By 3,727, my wife was giving art lessons for some extra cash. These were tough times, but each failure brought me closer to solving the problem. It wasn't the final prototype that made the struggle worth it. The process bore the fruit. I just kept at it."
Failure and Entrepreneurship. As detailed above, Dyson's first company ended with heartbreak. He describes it: "I was penniless again with no job and no income. I had three adorable children, a large mortgage to pay, and nothing to show for the past five years of toil. I had also lost my inventions. This was a very low moment and deeply worrying for Deirdre and me. It was deeply upsetting, too. My confidence took a big blow, and it would take some years to regain it." Part of being an entrepreneur is holding steadfast to a goal during times like these. Interestingly, an overview of psychological research on entrepreneurship helps us understand why failure and entrepreneurship are so closely linked. It all comes down to reflection. Only upon concrete failures do entrepreneurs enter a state of deep reflection on experiences that created the failure. After some time, the entrepreneur can become more enthusiastic and open with a new perspective on a problem or issue. The secret is getting to failure quite frequently or "Fail, Fast, Forward."

Business Themes

Never Listen to Consultants or Projections. Often venture capitalists pressure entrepreneurs into following attractive markets or trends. Dyson hates market research. He correctly points out that those doing market research are often wrong, and it makes no sense to trust someone who isn't in the industry building products and talking to customers constantly. As he puts it: "I was also putting into practice ideas I'd learned directly from Jeremy Fry and indirectly from Alec Issigonis: Don't copy the opposition. Don't worry about market research. Both Jeremy and Alec Issigonis might just as well have said "Follow your own star." And this is indeed what successful entrepreneurs do." You have to think differently than the market and competition to really arrive at a unique and differentiated product.
Accidental Success. One unobvious benefit of innovation, testing, trials, and not listening to consultants is "accidental" success. I think of unexpected success as the byproduct of curiosity and hard work. Every every hour you put into a tenuous venture adds a marble to the jar of unintended success. It's only after many hours that the marbles of success spill out. The Dyson Airblade is a clear example of the benefits of unintended innovation. The Dyson team was working on a small vacuum cleaner and had controversially decided to bring motor manufacturing in-house. Similar to Apple, Dyson likes to handle all of its manufacturing in-house, also known as a vertically integrated approach. After years of making motors internally with mixed success, his engineers noticed that one of their motors emitted air in a concentrated line. Although Dyson did not intend to make a hand dryer, it seemed like the perfect application for this new technology. It also was another market dominated by a few players (Excel Dryer, World Dryer) who last innovated a few decades ago. Dyson Airblades are now available all over the world.
James Musk and Elon Dyson. The similarities between James Dyson and Elon Musk are striking. Dyson's Dad died from cancer at an early age, which he acknowledges may have propelled his intensity and desire for control as he got older. Elon Musk had a complicated relationship with his Dad and suffered abuse for many years. Dyson was forced out of his ball-barrow company after the board ousted him as CEO. This company was his first venture, and the experience pushed him to assume complete ownership of Dyson after buying out Jeremy Fry in the 1990s. Elon was betrayed by the board of Zip2, his first company, after he took over following a dispute with former CEO Richard Sorkin. Musk was again fired from Paypal after disagreements with Peter Thiel and Max Levchin. Both founders entered markets that had lacked innovation for years, the vacuum industry and the car industry, with premium-priced products that work exceptionally well. Furthermore, these companies (Dyson, Tesla, and SpaceX) employ a unique design that is unlike other products in their respective markets and prioritize environmental benefits with their design. Although from different times and in different fields, I was surprised by how similar Elon and James are; maybe that's just a crazy person thing.

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July 2022 - Deep Work: Rules for Focused Success in a Distracted World

This month we learn about the explore popular productivity book Deep Work, by Cal Newport, a professor of theoretical computer science at Georgetown.

Tech Themes

Deep vs. Shallow. Just like Lady Gaga and Bradley Cooper, we, too, are trying to avoid the shallow. Newport starts his book with an overview of Deep Work compared to Shallow Work. Deep Work is focused, undistracted efforts at achieving the peak of your abilities. On the other hand, Shallow Work includes small, logistical tasks that the brain does not need to be entirely active to solve. Newport argues that more time should be spent in Deep mode. It leads to greater productivity and offers a way for individuals to differentiate themselves with the quality of work they do. In Newport's mind, the distracted Tiktok-obsessed world we currently inhabit is only getting more Shallow, so embracing Deep Work is the only way to survive. Shallow Work tends to involve lots of context switching from Task A to Task B. When this context-switching is repeated incessantly throughout the day, our ability to focus on anything diminishes, and we can end up in a permanent state of shallowness.
Deep Styles. Newport believes there are four core styles of Deep Work: Monastic, Bi-modal, Rhythmic, and Journalistic. The Monastic philosophy of Deep Work tries to completely eliminate all distractions. An example of Monastic Deep Work is famed computer science professor and Turing award winner Donald Knuth. Knuth does not have an email address. As he explains: "I have been a happy man ever since January 1, 1990, when I no longer had an email address. I'd used email since about 1975, and it seems to me that 15 years of email is plenty for one lifetime. Email is a wonderful thing for people whose role in life is to be on top of things. But not for me; my role is to be on the bottom of things. What I do takes long hours of studying and uninterruptible concentration. I try to learn certain areas of computer science exhaustively; then I try to digest that knowledge into a form that is accessible to people who don't have time for such study. On the other hand, I need to communicate with thousands of people all over the world as I write my books. I also want to be responsive to the people who read those books and have questions or comments. My goal is to do this communication efficiently, in batch mode --- like, one day every six months." Clearly, the monastic state tries to maximize deep work by shutting everything else out. The Bi-Modal philosophy asks the studier to program stretches of life wholly dedicated to Deep Work. Newport uses famous Penn psychology professor Adam Grant, as an example. Grant batches all of his teaching in the fall and all of his research in the spring. This schedule allows him to flip between modes into excellent-teacher Adam and excellent-researcher Adam. In these states, he's entirely dedicated to being the best at each subdomain, providing simplicity, clarity, and purpose to his routines and focus. Rhythmic philosophy entails finding certain times of day to work in stretches of Deep Work. This approach is the most accessible style of Deep Work for people who don't control their schedules. Newport recommends you plan out a week's worth of Deep Work in regular chunks to establish a routine for getting your mind ready to "Go Deep." The last Deep Work mode, the Journalistic philosophy, may be the most challenging style but can have incredibly intense effects. Newport gives Walter Issacson as an example here: "It was always amazing … he could retreat up to the bedroom for a while, when the rest of us were chilling on the patio or whatever, to work on his book … he'd go up for twenty minutes or an hour, we'd hear the typewriter pounding, then he'd come down as relaxed as the rest of us … the work never seemed to faze him, he just happily went up to work when he had the spare time." Find a philosophy that works for your current work structure!
Busyness != Productivity. In today's corporate world, many people equate busyness with productivity. Have I been sending and receiving emails all day? Have I been in meetings? Have I completed five zoom calls? These all feel vaguely productive, or maybe they don't. But either way, they take up large portions of our day. One only has to look at the hilarious new trend of young employees at mega-tech companies posting about their busy days doing what amounts to 3 hours of work while being spoiled by ridiculous offices and employee perks. Maybe this is why Facebook and Google have recently publicly told employees that their organizations are not very productive. Zuckerberg went as far as to say: "Realistically, there are probably a bunch of people at the company who shouldn't be here." Sundar Pichai created a "Simplicity Sprint "week to identify ways to make Google's 174,000 employees more productive. The world may be in for a more focused, intensely productive time with an imminent recession looming. Maybe that is why so many great companies are borne out of times of trouble?

Business Themes

Think Weeks and Unconcious Processing. Bill Gates is famous for taking two weeks a year completely off to set new directives for his life and professional work. We covered this in our June 2021 book regarding information overload in investing. Newport definitely likes the idea of Think Weeks - encouraging people to find separate locations from home or work to build creative momentum for the week. Individuals can also take some grand action, like traveling to a remote place or paying a significant sum for specialized accommodation to signal the importance of the work they are about to attempt. Newport also dives into the idea of unconscious processing or a work shutdown. Newport argues that downtime aids insights, helps recharge the energy needed to work deeply, and pushes us to focus only on necessary things (i.e. that nighttime email responses are usually not super important).
Four Disciplines of Execution (4DX). To help people in their Deep Work journies, Newport introduces us to the Four Disciplines of Execution (4DX), a framework created by the FranklinCovey company for helping companies work better. FranklinCovey is the business associated with Stephen Covey, and his highly successful 7 habits of Successful People and First Things First. His son Sean Covey, wrote and popularized 4DX. The four disciplines espoused by the framework are: (1) Focus on the Wildly Important, (2) Act on Lead Measures, (3) Keep a Compelling Scoreboard, and (4) Create a Cadence of Accountability. Clearly, the first discipline focuses on identifying the significant goals we want to achieve. The second discipline is a bit more nuanced and prompts us to think more about the inputs to success rather than the success itself. As an example, a company might have a revenue target for the year, but that target could be broken down into simple actions by the sales team to reach out to customers, understand use cases, and position the company's product to help. Discipline 2 argues that we should focus on these leading indicators of success rather than revenue achievement itself. The third discipline is about creating consistency and identifying success. Jerry Seinfeld offers a great example of this practice: "He [Jerry Seinfeld] told me to get a big wall calendar that has a whole year on one page and hang it on a prominent wall. The next step was to get a big red magic marker. He said for each day that I do my task of writing, I get to put a big red X over that day. 'After a few days you'll have a chain. Just keep at it and the chain will grow longer every day. You'll like seeing that chain, especially when you get a few weeks under your belt. Your only job next is to not break the chain.' 'Don't break the chain,' he said again for emphasis." This advice likely explains the phenomenon of maintaining Snapchat streaks at all costs. The fourth discipline is about establishing accountability for achieving the goals set out during the previous week. FranklinCovey insists that you hold yourself accountable each week. Hopefully, all that's needed is a 15-minute scheduled window to see your progress. The 4DX method is straightforward, clear, and helpful for executing any goal.
Amp it Up. In the spirit of next month's TBOTM, let's talk about amping up the intensity of our Deep Work. Newport discusses the early and incredible success of Teddy Roosevelt in what seemed like everything he tried. As one blogger notes: "While at Harvard, TR developed an intense study or "deep work" attitude. He would schedule every minute of his day including every activity, meal breaks, and classes. Any "spare time" was slated for study - study that did not include daydreams, sips of tea or any sign of indecision. He focused, without breaks, an intense frenzy of concentrated energy." As BusinessInsider notes, the way to incorporate this into our lives is by: "Newport says one way to incorporate rewarding deep work into your life is 'to inject the occasional dash of Rooseveltian intensity into your own workday.' This entails selecting a high-priority task, estimating how much time it would normally take you, and then creating a deadline well below the typical allotted time." Newport, a theoretical computer scientist, has a formula for how to describe this strategy: Quality Work (QW) = time Spent x Intensity. Quality work therefore does not always need to be achieved through laboring hours but can instead be supplemented with blistering intensity and focus. How do you achieve this superior intensity? There is no theory for becoming a more intense worker, but Newport believes that work intensity is a muscle that can be honed over time with more and more efforts of intense, Deep Work.

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June 2022 - Whistleblower: My Journey to Silicon Valley and Fight For Justice at Uber by Susan Fowler

This month we learn about the crazy culture at Uber and how it perpetrated repeated discrimination against groups of people, until someone did something about it. Then Susan Fowler - a software engineer at Uber, put pen to paper on a seminal blog post that upended Uber and the world.

Tech Themes

Software Engineering Diversity. Diversity has been a challenge for technology companies, despite overwhelming rhetoric about its importance. A 2022 report by Celential.ai highlighted that only 21% of software engineers are women. More concerning, is that this percentage has been falling in recent years, with zippia estimating that the percentage of female software engineers was closer to ~31% in 2011. Susan Fowler experienced this sad statistic multiple times - when she joined Plaid, a fintech startup with 13 employees, there were only two women. After switching to the networking startup, Pubnub, Fowler found herself the only woman on the engineering team, which was made worse by her boss who was “openly, unabashedly sexist.” So Fowler was very excited when her interviewer at Uber noted: “Twenty-five percent of our engineers are women.” But that joy was short-lived. Just one year after receiving her team assignment (Site reliability engineering), her team had gone from 25% women to just 6% due to repeated harassment by team managers. Sadly, sexual harassment seems like the norm in the tech industry with 78% of female founders saying they’ve been sexually harassed or know someone else who has. The tech industry has a lot to improve to make companies more diverse with less harassment.
Abuse, Burnout, and Fatigue. Software engineering can be a grind. Day in, and day out, you are typing at your computer, sometimes rarely interacting with other people. Fowler quickly figured out that Uber’s managers had a common approach to get people motivated, negative personal attacks and abuse. As Fowler noted relatively early on in her Uber journey: “I dreaded going into work, knowing that I’d be yelled at in meetings, that I’d be told I wasn’t ‘doing my job,’ that I wasn’t ‘working hard enough,’ even though I was doing everything that my managers asked of me. I wasn’t the only one who felt this way. When I told my friends in the other site reliability engineering teams what was going on, they said they had the same problems with their managers and teams, too. Almost every single one of them had started seeing a therapist for anxiety and depression related to the culture of work at uber; the engineers who had been at uber the longest all seemed to have suicidal thoughts.” Fowler was determined to escape this constant anxiety, so she applied to switch teams, only to have the transfer blocked by her manager. Her manager went so far as to imply that women couldn’t be good site reliability engineers, claiming “ Some people have things about them that are performance problems. These aren’t things about their work or the kind of work they do, but who they are.” Insane! Abuse, depression, anxiety, and burnout are sadly norms in the tech world, with 60% of tech workers reporting burnout in a team Blind survey. Tech cultures can feed on themselves with increasing hours leading to small productivity gains that lead to promotions and an ever-intensifying culture. Some gave developers have worked 24 hours straight testing games. The software engineering world needs better managers that understand how to help engineers avoid burnout.
Site Reliability Engineering. Fowler worked as a Site Reliability Engineer at Uber, which is a relatively new engineering role that was popularized by Google. According to Red Hat, “SRE teams use software as a tool to manage systems, solve problems, and automate operations tasks.” Site Reliability Engineering generally manages production infrastructure and ensure that companies can meet their Service Level Agreements for service uptime. When Fowler joined Uber, she noticed that the company lacked standardization across its SRE practices. Fowler noted: “Over a thousand independent microservices, spread out across countless engineering teams, all had to work together for the Uber app to function correctly; these microservices didn’t always work together the way they needed to, and the lack of standardization was large to blame. Whenever these systems failed because they didn’t meet the basic standards of building reliable software, it meant that riders were abandoned, drivers weren’t paid, and destinations were lost mid-trip.” Fowler tackled this problem by compiling a list of architecture standards that worked for each team, and then devised a system to certify that microservices were “production-ready.” Her work helped improve the standards for software at Uber and increased their micro-service uptime.

Business Themes

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Stoicism and Doing What's Right. Susan Fowler was an outsider to Silicon Valley. She grew up in poverty in a rural suburb of Phoenix. Her parents were faithful believers in Christianity, and her Dad worked as a pastor while her mother stayed at home and homeschooled her children. However, when Fowler got to high school, her Mom re-entered the workforce as a teacher, and her Dad decided to pursue a degree in education. Despite trying desperately to enter the public school system, Fowler was rebuffed and told that she wasn't competent enough to enroll in an Arizona high school. As a result, she got a job working as a nanny and studied textbooks at night with the hope of schooling herself. During this intensely lonely period of her life, she rediscovered some of her favorite books, including the Greek philosophers known as the stoics. Fowler recalls the pivotal moment of her life: "As I sat there among the books that I had been reading for the last few years, thinking about the stories that they told of great people and the great things they had done, it suddenly occurred to me: these were stories about people who had done things in their lives, not had things done to them, who had made things happen in their lives, not had things happen to them." This revelation prompted a seething desire to get a formal education and gain personal autonomy. She accomplished this by attending Arizona State, then the University of Pennsylvania, and ultimately graduating with a degree in physics. The stoic mindset was pivotal in her decision to ultimately publish the blog post that made her famous. The Stoics teach that you must do was is morally right. Fowler recalls: "I didn't know what to do. I felt, deep in my heart that writing my story and sharing it with the world was the right thing to do but the possible consequences were so awful that I couldn't believe it was something I was actually morally obligated to do...And then it hit me: I had no way of possibly knowing what the consequences of my actions would be. I had no idea what would actually happen if I wrote the blog." Fowler's philosophical growth laid the foundation for her to speak out when she saw truly abhorrent behavior, and the world is undeniably better for it.
Early Culture Importance. As ride-hailing platforms exploded world-wide, Uber was a business in open defiance of the law. "Travis Kalanick and his team were operating in cities across the world without permission, unashamedly breaking and disregarding laws and regulations – all in the name of 'hustle' and 'disruption.'" The HBO series about Uber called Superpumped, an Uber cultural value, depicts this intense hustle-or-die culture. Beyond the abuse, the sexual harassment, and the HR violations, Uber filled its management ranks with corporate ladder climbers clamoring for closer positions to "TK." Fowler recalled: "Nothing was off-limits in these petty power games: projects were sabotaged, rumors were spread, employees were used as pawns." Interestingly enough, Uber had all the makings of what would be considered good diversity and inclusion practices – unconscious bias training, anti-harassment, and anti-discrimination training, employee surveys, support groups, women on the board, and women in management positions. But the company was rotten from the inside out because of its operations. "The issue wasn't that Uber needed to be more diverse and inclusive; the issue was that Uber had a culture that ignored and violated civil and employment laws." Uber had 14 cultural values, which is too many for any company. Culture is established early in companies and can be the complete unwinding of a company if not very carefully managed as the company grows.
Human Resources. Nothing exemplifies Uber's broken culture more than Fowler's disturbing first day on her SRE team. As she sat down to work finishing up onboarding tasks, her new manager Jake started to slack her incessantly about his open relationship and approach to sexual relationships. Because of Susan's past dealing with the completely unjust due process at Penn, she immediately screenshotted the messages and promptly reported Jake to HR. However, after a brief meeting in a different building, she was told that this was Jake's first offense and that the company wouldn't be taking any action against him. Later, Fowler would uncover that numerous people had complained specifically about Jake and Uber had lobbied the same excuse. This inexplicable communication was just the beginning of HR nightmares at Uber – some of which violated employment law. So what were the issues with Uber's HR department? First, Uber's HR department was woefully small, with one source suggesting it was close to 10 people to manage 11,000 employees. In addition, the Head of HR reported to Ryan Graves, a co-founder and its then Head of operations, rather than CEO Travis Kalanick. This misalignment in reporting structure meant that Renee Atwood, then Head of HR, had to report challenging HR situations to Graves, whom some claimed wasn't equipped to handle the growing complexity of these situations appropriately. To handle the mounting controversies surrounding Uber after Fowler's blog post, the board hired Eric Holder, a former US Attorney General to investigate Fowler's claims. The final report is mostly internal, but the recommendations of Holder's firm Covington are public. When all was said and done, Uber fired Travis Kalanick, and replaced him with Dara Khosrowshahi, a former Expedia CEO and Allen and Co. Managing Director.

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May 2022 - Play Nice, But Win by Michael Dell and James Kaplan

This month we dive into the history of Dell Computer Corporation, one of the biggest PC and server companies in the world! Michael Dell gives a first-hand perspective of all of Dell’s big successes and failures throughout the years and his intense battle with Carl Icahn, over the biggest management buyout in history.

Tech Themes

Be a Tinkerer. When he was in seventh grade, Michael Dell begged his parents to buy an Apple II computer (which costs ~$5,000 in today's dollars). Immediately after the computer arrived, he took the entire thing apart to see exactly how the system worked. After diving deep into each component, Dell started attending Apple user groups. During one, he met a young and tattered Steve Jobs. Dell began tutoring people on the Apple II's components and how they could get the most out of it. When IBM entered the market in 1980 with the 5150 computer, he did the same thing - took it apart, and examined the components. He realized that almost everything IBM made came from other companies (not IBM) and that the total value of its components was well below the IBM price tag. From this simple insight, he had a business. He started fixing up a couple of computers for local business people in Austin. Dell's machines cost less and delivered more performance. The company got so big (50k - 80k revenue per month) that during his freshman year at UT Austin, Dell decided to drop out, much to his parent's dismay. On May 3rd, 1984, Dell incorporated his company and never returned to school.
Lower Prices and Better Service - a Powerful Combination. Dell Computer Corporation was the original DTC business. Rather than selling in big box retail stores, Dell carried out orders via mail request. When the internet became prominent in the late 90s, Dell started taking orders online. After his insight that the cost of components was significantly lower than the selling price, he flew to the far east to meet his suppliers. He started placing big deals and getting better and better prices. This strategy is the classic low-end disruption pattern that we learned about in Clayton Christensen's, The Innovator's Dilemma – a lowered-priced competitor that offers better service, customizability starts to crush the competition. Christensen is important to note that the internet itself was a sustaining innovation to Dell, but very disruptive to the market as a whole: "Usually, the technology simply is an enabler of the disruptive business model. For example, is the Internet a disruptive technology? You can't say that. If you bring it to Dell, it's a sustaining technology to what Dell's business model was in 1996. It made their processes work better; it helped them meet Dell's customers' needs at lower cost. But when you bring the very same Internet to Compaq, it is very disruptive [to the company's then dealer-only sales model]. So how do we treat that? We praise [CEO Michael] Dell, and we fire Eckhard Pfeiffer [Compaq's former CEO]. In reality, those two managers are probably equally competent." If competitors lowered prices, Dell could find better components and continually lower prices. Dell's strategy led to many departures from the personal PC market – IBM left, HP acquired Compaq in a disastrous deal for HP, and many others never made it back.
Layoffs, Crises, and Opportunities. Dell IPO'd in 1988 and joined the Fortune 500 in 1991 as they hit $800m in sales for the year. So you would think the company would be humming when it hit $2B in sales in 1993, right? Wrong. Everything was breaking. When a company scales that quickly, it doesn't have time to create processes and systems. Personnel issues began to happen more frequently. As Dell recalls, the head of sales had a drinking problem, and the head of HR had a stripper girlfriend on the payroll. The company was late to market with notebooks, and it had to institute a recall on its notebooks which could catch fire in some instances. During that time, Dell hired Bain to do an internal report about how it should change its processes for its new scale – Kevin Rollins of the Bain team knew the business super well and thought incredibly strategically. After the Bain assignment, Rollins joined the company as Vice-chairman, ultimately becoming CEO for a brief period in 2004. One of his first recommendations was to cease its experiment selling through department stores and to stay DTC-focused. During the internet bubble, Dell faced another crisis – its stock had risen precipitously for many years, but once the bubble burst, in a matter of months, it fell from $50 to $17 a share. The company missed its earnings estimates for five quarters in a row and had to do two layoffs – one with 1,700 people and another with 4,000. During this time, an internal poll showed that 50% of Dell team members would leave if another company paid them the same rate. Dell realized that the values statement he had written in 1988 was no longer resonating and needed updating – he refreshed the value statement and focused the company on its role in the global IT economy. Dell understands that you should never waste a great crisis, and always find the opportunity for growth and improvement when things aren't going well.

Business Themes

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Carl Icahn and Dell. No one in business represents a corporate nemesis quite like Carl Icahn. Icahn was born in Rockaway, NY, and earned his tuition money at Princeton playing poker against the rich kids. Icahn is an activist investor and popularized the field of activist investing with some big, bold battles against companies in the early 1980s. Icahn got his start in 1968 by purchasing a seat on the New York Stock Exchange. He completed his first major takeover attempt in 1978, and the rest was history. Icahn takes an intense stance against companies, typically around big mergers, acquisitions, or divestitures. He 1) buys up a lot of shares, like 5-10% of a company, 2) accuses the company and usually the management of incompetence or a lousy strategy 3) argues for some action - a sale of a division, a change in management, a special dividend 4) sues the company in a variety of ways around shareholder negligence 5) sends letters to shareholders and the company detailing his findings/claims 6) puts up a new slate of board members at the company 7) waits to profit or gets paid to go away (also called greenmail). Icahn used these exact tactics when he took on Michael Dell. Icahn issued several scathing letters about Dell, criticizing the company's poor performance, highlighting Michael Dell's obvious conflicts of interest as CEO, and demanding the special committee evaluate the deal fairly. Icahn normally makes money when he gets involved, and he is essentially a gnat that doesn't go away until he makes money one way or another. After the fight, Icahn still made a profit of 10s of millions, and his fight with Dell was just beginning.
Take Privates and Transformation. Michael Dell had thought a couple of times about taking the company private when he was approached by Egon Durban of Silver Lake Partners, a large tech private equity firm. Dell and Zender went on a walk in Hawaii and worked out what a transaction might be. The issue with Dell at that time was that the PC market was under siege. People thought tablets were the future, and their questions found confirmation in the PC market's declining volumes. Dell had spent $14B on an acquisition spree, acquiring a string of enterprise software companies, including Quest Software, SonicWall, Boomi, Secureworks, and more, as it redirected its strategy. But these companies had yet to kick into gear, and most of Dell's business was still PCs and servers. The stock price had fallen about 45% since Michael Dell had rejoined as CEO in 2007. Dell had thought about taking the company private a couple of other times, but now seemed like a great time - they needed to transform, and fast. Enacting a transformation in the public markets is tough because wall street focuses on quarter-to-quarter metrics over long-term vision. He first considered the idea in June 2012 when talking with the then largest shareholder Southeastern Asset Management. After letting the idea percolate, Dell held discussions with Silver Lake and KKR. Silver Lake and Dell submitted a bid at $12.70, then $12.90, then $13.25, then $13.60, then $13.65. On February 4th, 2013, the special committee accepted Silver Lake's offer. On March 5th, Carl Icahn entered the fray, saying he owned about $1b of shares. Icahn submitted a half proposal suggesting the company pay a one-time special dividend, he would acquire a substantial part of the stock and it would remain public, under different leadership. On July 18th, the special committee delayed a vote on the acquisition because it became clear that Dell couldn't get enough of the "majority of the minority" votes needed to close the acquisition. A few weeks later, Silver Lake and Dell raised their bid to $13.75 (the original asking price of the committee), and the committee agreed to remove the voting standard, allowing the SL/Dell combo to win the deal. After various lawsuits, Icahn gave up in September 2013, when it became clear he had no strategy to convince shareholders to his side. It was an absolute whirlwind of a deal process, and Dell escaped with his company.
Big Deals. After Dell went private, Michael Dell and Egon Durban started scouring the world for enticing tech acquisitions. They closed on a small $1.4B storage acquisition, which reaffirmed Michael Dell's interest in the storage market. After the deal, Dell reconsidered something that almost happened in 2008/09 – a merger with EMC. EMC was the premier enterprise storage company with a dominant market share. On top of that, EMC owned VMware, a software company that had successfully virtualized the x86 architecture so servers could run multiple operating systems simultaneously. Throughout 2008 and 2009, Dell and EMC had deeply considered a merger – to the point that its boards held joint discussions about integration plans and deal price. The boards scrapped the deal during the financial crisis, and in the ensuing years, EMC grew and grew. By 2014 it was a $59B public company and the largest company in Massachusetts. In mid-2014, Dell started to consider the idea. He pondered the strategic and competitive implications of the deal everywhere he went. Little did he know that he was already late to the party – it later came out that both HP and Cisco had looked at acquiring EMC in 2013. HP got down to the wire, with the deal being championed by Meg Whitman, as a way to move past the Autonomy debacle and board room in-fighting. HP had a handshake agreement to merge with EMC in a 1:1 deal, but at the last minute, HP re-traded and demanded a more advantageous split (i.e. HP would own 55% of the combined company) and EMC said no. When EMC then turned to Dell, Whitman slammed the deal. While the only remaining competitor of size was Dell, there was still a question of how they could finance the deal, especially as a private company. Dell's ultimate package was a pretty crazy mix of considerations: Dell issued a tracking stock related specifically to Dell's business, it then took out some $40b in loans against its newly acquired VMWare equity and the cash flow of Dell's underlying business, Michael Dell and Silver lake also put in an additional $5B of equity capital. After Silver Lake and Dell determined the financing structure, Dell faced a grueling interrogation session in front of the EMC board as final approval for the deal. The deal was announced on October 12th, 2015, and it closed a year later. By all measures, it appears the deal was a success – the company has undergone a complete transformation – shedding some acquired assets, spinning off VMWare, and going public again by acquiring its own tracking stock. Michael Dell took some huge risks - taking his company private and completing the biggest tech merger in history. It seems to have paid off handsomely.

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April 2022 - Ask Your Developer by Jeff Lawson

This month we check out Jeff Lawson’s new book about API’s. Jeff was a founder and the first CTO at Stubhub, an early hire at AWS, and started Twilio in 2008. He has a very interesting perspective on the software ecosystem as it stands today and what it looks like in the future!

Tech Themes

Start with the Problem, Not the Solution. Lawson repeats a mantra throughout the book related to developers: "Start with the problem, not the solution." This is something that Jeff learned as an early hire at AWS in 2004. Before AWS, Lawson had founded and sold a note-taking service to an internet flame out, co-founded Stubhub as its first CTO, and worked at an extreme sports retailer. His experience across four startups has guided him to a maniacal focus on the customer, and he wants that focus to extend to developers. If you tell developers the exact specification for something and give no context, they will fail to deliver great code. Beginning with the problem and the customer's specific description allows developers to use their creativity to solve the issue at hand. The key is to tell developers the business problem and how the issue works, let them talk to the customer, and help them understand it. That way, developers can use their imaginative, creative problem-solving abilities.
Experiment to Innovate. Experimentation is at the root of invention, which drives business performance over the long term. Jeff calls on the story of the Wright Brothers to illustrate this point. The Wright Brothers were not the first to try to build a flying vehicle. When they achieved flight, they beat out a much better-funded competitor by simply doing something the other person wouldn't do – crash. The Wright brothers would make incremental changes to their flying machine, see what worked, fly it, crash it, and update the design again. The other competitor, Samuel Pierpont Langley, spent heavily on his "aerodome" machine (~$2m in today's dollars) and tried to build the exact specs of a flying machine but didn't run these quick and fast (and somewhat calamitous) experiments. This process of continual experimentation and innovation is the hallmark of a great product organization. Lawson loves the lean startup and its idea of innovation accounting. In innovation accounting, teams document exact experiments, set expectations, hypotheses, target goals, and then detail what happens in the experiment. Think of this as a lab notebook for product experimentation. When doing these experiments, they must have a business focus rather than just a technical ramification. Jeff always asks: "What will this help our customers do?" when evaluating experimentation and innovation. Agile - features, deadlines, quality, certainty - choose 3.
Big Ideas Start Small. In 1986, famous computer scientist Fred Brooks, published a paper called No Silver Bullet, detailing how to manage software teams. Brooks contends that adding more developers and spending more money seldom gets a project to completion faster – normally, it does the opposite. Why is this? New people on the team need time to ramp up and get familiar with the code-base, so they are low productivity at the start. Additionally, developers on the project take a lot of time explaining the code base to new developers joining late. Lawson uses the example of GE Digital to show the issues of overinvesting when starting. Jeff Immelt started as CEO of GE in 2001, and later proclaimed in 2014 that GE would launch a new software/IoT division that would be a meaningful part of their future business. GE invested tons of money into the venture and put experienced leaders on the project; however, it generated minimal profit years later. Despite acquisitions like ServiceMax (later divested), the company spent hundreds of millions with hardly any return. Lawson believes the correct approach would be to invest in 100 small product teams with $1m each, and then as those ideas grow, add more $. This idea of planting seeds and seeing which ones flower and then investing more is the right way to do it, if you can. Start small and slowly gather steam until it makes sense to step on the gas.

Business Themes

Software Infrastructure is Cheap. Software infrastructure has improved dramatically over the last fifteen years. In 2007, if you wanted to start a business, you had to buy servers, configure them, and manage your databases, networking equipment, security, compliance, and privacy. Today that is all handled by the cloud hyperscalers. Furthermore, new infrastructure providers sprouted as the cloud grew that could offer even better, specialized performance. On top of core cloud services like storage and compute, new companies like Datadog, Snowflake, Redis, Github, all make it easy to startup infrastructure for your software business. On top of that, creative tools are just as good. Lawson calls to mind the story of Lil Nas X, the now-famous rapper, who bought a beat online for $30, remixed it and launched it. That beat became "Old Town Road," which went 15x platinum and is now rated 490th on the list of best songs of all time. The startup costs for a new musician, software company, or consumer brand are very low because the infrastructure is so good.
Organization Setup. Amazon has heavily influenced Lawson and Twilio, including Bezos's idea of two-pizza teams. The origin story of two pizza teams comes from a time at Amazon when teams were getting bigger and bigger, and people were becoming more removed from the customer. Slowly, many people throughout the company had almost no insight into the customer and their issues. Jeff introduced cutting his organization into two-pizza teams, i.e. two pizzas could reasonably feed the team. Lawson has adopted this in spades, with Twilio housing over 150 two-pizza teams. Every team has a core customer, whether internal or external. If you are on the platform infrastructure team, your customer may be internal developers who leverage the infrastructure team's development pipelines. If you are on the Voice team, your customer may be actual end customers building applications with Twilio's API-based voice solution. When these teams get large (beyond two pizzas), there is a somewhat natural process of mitosis, where the team splits into two. To do this, the teams detangle their respective codebases and modularize their service so other teams within the company can access it. They then set up collaboration contacts with their closely related teams; internally, everyone monitors how much they use each other microservice across the company. This monitoring allows companies to see where they may need to deploy more resources or create a new division.
Hospitality. Many companies claim to be customer-focused, but few are. Amazon always leaves an empty chair in conference rooms to symbolize the customer in every meeting. Jeff Lawson and Twilio extended this idea – he asked customers for their shoes (the old adage: "walk a mile in someone's shoes") and then hung them throughout Twilio's office. Jeff is intensely focused on the customer and likens his approach to the one famous restauranteur Danny Meyer takes to his restaurants. Danny focuses on this idea of hospitality. In Danny's mind, hospitality goes beyond just focusing on the customer; it makes the customer feel like they are on the business side. While it may be hard to imagine this, everyone knows this feeling when someone goes out of their way to ensure that you have a positive experience. Meyer extends this to an idea about a gatekeeper vs. an agent. A gatekeeper makes it feel like they sit in between you and the product; they remove you from whats happening and make you feel like you are being pushed to do things. In contrast, an agent is a proactive member of an organization that tries to build a team-like atmosphere between the company and the individual customer. Beyond the customer focus, Jeff extends this to developers – developers want autonomy, mastery, and purpose. They want a mission that resonates with them, the freedom to choose how they approach development, and the ability to learn from the best around them. The idea of hospitality exists among all stakeholders of a business but, most importantly, employees and customers.

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March 2022 - Invent and Wander by Jeff Bezos

This month we go back to tech giant Amazon and review all of Jeff Bezos’s letters to shareholders. This book describes Amazon’s journey from e-commerce to cloud to everything in a quick and fascinating read!

Tech Themes

The Customer Focus. These shareholder letters clearly show that Amazon fell in love with its customer and then sought to hammer out traditional operational challenges like cycle times, fulfillment times, and distribution capacity. In the 2008 letter, Bezos calls out: "We have strong conviction that customers value low prices, vast selection, and fast, convenient delivery and that these needs will remain stable over time. It is difficult for us to imagine that ten years from now, customers will want higher prices, less selection, or slower delivery." When a business is so clearly focused on delivering the best customer experience, with completely obvious drivers, its no wonder they succeeded. The entirety of the 2003 letter, entitled "What's good for customers is good for shareholders" is devoted to this idea. The customer is "divinely discontented" and will be very loyal until there is a slightly better service. If you continue to offer lower prices on items, more selection of things to buy, and faster delivery - customers will continue to be happy. Those tenants are not static - you can continually lower prices, add more items, and build more fulfillment centers (while getting faster) to keep customers happy. This learning curve continues in your favor - higher volumes mean cheaper to buy, lower prices means more customers, more items mean more new customers, higher volumes and more selection force the service operations to adjust to ship more. The flywheel continues all for the customer!
Power of Invention. Throughout the shareholder letters, Bezos refers to the power of invention. From the 2018 letter: "We wanted to create a culture of builders - people who are curious, explorers. They like to invent. Even when they're experts, they are "fresh" with a beginner's mind. They see the way we do things as just the way we do things now. A builder's mentality helps us approach big, hard-to-solve opportunities with a humble conviction that success can come through iteration: invent, launch, reinvent, relaunch, start over, rinse, repeat, again and again." Bezos sees invention as the ruthless process of trying and failing repeatedly. The importance of invention was also highlighted in our January book 7 Powers, with Hamilton Helmer calling the idea critical to building more and future S curves. Invention is preceded by wandering and taking big bets - the hunch and the boldness. Bezos understands that the stakes for invention have to grow, too: "As a company grows, everything needs to scale, including the size of your failed experiments. If the size of your failures isn't growing, you're not going to be inventing at a size that can actually move the needle." Once you make these decisions, you have to be ready to watch the business scale, which sounds easy but requires constant attention to customer demand and value. Amazon's penchant for bold bets may inform Andy Jassy's recent decision to spend $10B making a competitor to Elon Musk/SpaceX's Starlink internet service. This decision is a big, bold bet on the future - we'll see if he is right in time.
Long-Term Focus. Bezos always preached trading off the short-term gain for the long-term relationship. This mindset shows up everywhere at Amazon - selling an item below cost to drive more volumes and give consumers better prices, allowing negative reviews on sites when it means that Amazon may sell fewer products, and providing Prime with ever-faster and free delivery shipments. The list goes on and on - all aspects focused on building a long-term moat and relationship with the customer. However it's important to note that not every decision pans out, and it's critical to recognize when things are going sideways; sometimes, you get an unmistakable punch in the mouth to figure that out. Bezos's 2000 shareholder letter started with, "Ouch. It's been a brutal year for many in the capital markets and certainly for Amazon.com shareholders. As of this writing, our shares are down more than 80 percent from when I wrote you last year." It then went on to highlight something that I didn't see in any other shareholder letter, a mistake: "In retrospect, we significantly underestimated how much time would be available to enter these categories and underestimated how difficult it would be for a single category e-commerce companies to achieve the scale necessary to succeed…With a long enough financing runway, pets.com and living.com may have been able to acquire enough customers to achieve the needed scale. But when the capital markets closed the door on financing internet companies, these companies simply had no choice but to close their doors. As painful as that was, the alternative - investing more of our own capital in these companies to keep them afloat- would have been an even bigger mistake." During the mid to late 90s, Amazon was on an M&A and investment tear, and it wasn't until the bubble crashed that they looked back and realized their mistake. Still, optimizing for the long term means admitting those mistakes and changing Amazon's behavior to improve the business. When thinking long-term, the company continued to operate amazingly well.

Business Themes

Free Cash Flow per Share. Despite historical rhetoric that Bezos forewent profits in favor of growth, his annual shareholder letters continually reinforce the value of upfront cash flows to Amazon's business model. If Amazon could receive cash upfront and manage its working capital cycle (days in inventory + days AR - days AP), it could scale its operations without requiring tons of cash. He valued the free cash flow per share metric so intensely that he spent an entire shareholder letter (2004) walking through an example of how earnings can differ from cash flow in businesses that invest in infrastructure. This maniacal focus on a financial metric is an excellent reminder that Bezos was a hedge fund portfolio manager before starting Amazon. These multiple personas: the hedge fund manager, the operator, the inventor, the engineer - all make Bezos a different type of character and CEO. He clearly understood financials and modeling, something that can seem notoriously absent from public technology CEOs today.
A 1,000 run home-run. Odds and sports have always captivated Warren Buffett, and he frequently liked to use Ted Williams's approach to hitting as a metaphor for investing. Bezos elaborates on this idea in his 2014 Letter (3 Big Ideas): "We all know that if you swing for the fences, you're going to strike out a lot, but you're also going to hit some home runs. The difference between baseball and business, however, is that baseball has a truncated outcome distribution. When you swing, no matter how well you connect with the ball, the most runs you can get is four. In business, every once in a while, when you step up to the plate, you can score one thousand runs. This long-tailed distribution of returns is why its important to be bold. Big winners pay for so many experiments." AWS is certainly a case of a 1,000 run home-run. The company incubated the business and first wrote about it in 2006 when they had 240,000 registered developers. By 2015, AWS had 1,000,000 customers, and is now at a $74B+ run-rate. This idea also calls to mind Monish Pabrai's Spawners idea - or the idea that great companies can spawn entirely new massive drivers for their business - Google with Waymo, Amazon with AWS, Apple with the iPhone. These new businesses require a lot of care and experimentation to get right, but they are 1,000 home runs, and taking bold bets is important to realizing them.
High Standards. How does Amazon achieve all that it does? While its culture has been called into question a few times, it's clear that Amazon has high expectations for its employees. The 2017 letter addresses this idea, diving into whether high standards are intrinsic/teachable and universal/domain-specific. Bezos believes that standards are teachable and driven by the environment while high standards tend to be domain-specific - high standards in one area do not mean you have high standards in another. This discussion of standards also calls back to Amazon's 2012 letter entitled "Internally Driven," where Bezos argues that he wants proactive employees. To identify and build a high standards culture, you need to recognize what high standards look like; then, you must have realistic expectations for how hard it should be or how long it will take. He illustrates this with a simple vignette on perfect handstands: "She decided to start her journey by taking a handstand workshop at her yoga studio. She then practiced for a while but wasn't getting the results she wanted. So, she hired a handstand coach. Yes, I know what you're thinking, but evidently this is an actual thing that exists. In the very first lesson, the coach gave her some wonderful advice. 'Most people,' he said, 'think that if they work hard, they should be able to master a handstand in about two weeks. The reality is that it takes about six months of daily practice. If you think you should be able to do it in two weeks, you're just going to end up quitting.' Unrealistic beliefs on scope – often hidden and undiscussed – kill high standards." Companies can develop high standards with clear scope and corresponding challenge recognition.

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February 2022 - Cable Cowboy by Mark Robichaux

This month we jump into the history of the cable industry in the US with Cable Cowboy. The book follows cable’s main character for over 30 years, John Malone, the intense, deal-addicted CEO of Telecommunications International (TCI).

Tech Themes

Repurposed Infrastructure. Repurposed infrastructure is one of the incredible drivers of technological change covered in Carlota Perez’s Technology Revolutions and Financial Capital. When a new technology wave comes along, it builds on the backs of existing infrastructure to reach a massive scale. Railroads laid the foundation for oil transport pipelines. Later, telecommunications companies used the miles and miles of cleared railroad land to hang wires to provide phone service through the US. Cable systems were initially used to pull down broadcast signals and bring them to remote places. Over time, more and more content providers like CNN, TBS, BET started to produce shows with cable distribution in mind. Cable became a bigger and bigger presence, so when the internet began to gain steam in the early 1990s, Cable was ready to play a role. It just so happened that Cable was best positioned to provide internet service to individual homes because, unlike the phone companies’ copper wiring, Cable had made extensive use of coaxial fiber which provided much faster speeds. In 1997, after an extended period of underperformance for the Cable industry, Microsoft announced a $1B investment in Comcast. The size of the deal showed the importance of cable providers in the growth of the internet.
Pipes + Content. One of the major issues surrounding TCI as they faced anti-trust scrutiny was their ownership of multiple TV channels. Malone realized that the content companies could make significant profits, especially when content was shown across multiple cable systems. TCI enjoyed the same Scale Economies Power as Netflix. Once the cable channel produces content, any way to spread the content cost over more subscribers is a no-brainer. However, these content deals were worrisome given TCI’s massive cable presence (>8,000,000 subscribers). TCI would frequently demand that channels take an equity investment to access TCI’s cable system. “In exchange for getting on TCI systems, TCI drove a tough bargain. He demanded that cable networks either allow TCI to invest in them directly, or they had to give TCI discounts on price, since TCI bought in bulk. In return for most-favored-nation-status on price, TCI gave any programmer immediate access to nearly one-fifth of all US subscribers in a single stroke.” TCI would impose its dominant position - we can either carry your channel and make an investment, or you can miss out on 8 million subscribers. Channels would frequently choose the former. Malone tried to avoid anti-trust by creating Liberty Media. This spinoff featured all of TCI’s investments in cable providers, offering a pseudo-separation from the telecom giant (although John Malone would completely control liberty).
Early, Not Wrong. Several times in history, companies or people were early to an idea before it was feasible. Webvan formed the concept of an online grocery store that could deliver fresh groceries to your house. It raised $800M before flaming out in the public markets. Later, Instacart came along and is now worth over $30B. There are many examples: Napster/Spotify, MySpace/Facebook, Pets.com/Chewy, Go Corporation/iPad, and Loudcloud/AWS. The early idea in the telecom industry was the information superhighway. We’ve discussed this before, but the idea is that you would use your tv to access the outside world, including ordering Pizza, accessing bank info, video calling friends, watching shows, and on-demand movies. The first instantiation of this idea was the QUBE, an expensive set-top box that gave users a plethora of additional interactive services. The QUBE was the launch project of a joint venture between American Express and Warner Communications to launch a cable system in the late 1970s. The QUBE was introduced in 1982 but cost way too much money to produce. With steep losses and mounting debt, Warner Amex Cable “abandoned the QUBE because it was financially infeasible.” In 1992, Malone delivered a now-famous speech on the future of the television industry, predicting that TVs would offer 500 channels to subscribers, with movies, communications, and shopping. 10 years after the QUBE’s failure, Time Warner tried to fulfill Malone’s promise by launching the Full-Service Network (FSN) with the same idea - offering a ton of services to users through a specialized hardware + software approach. This box was still insanely expensive (>$1,000 per box) because the company had to develop all hardware and software. After significant losses, the project was closed. It wasn’t until recently that TV’s evolved to what so many people thought they might become during those exciting internet boom years of the late 1990s. In this example and several above, sometimes the idea is correct, but the medium or user experience is wrong. It turned out that people used a computer and the internet to access shop, order food, or chat with friends, not the TV. In 2015, Domino’s announced that you could now order Pizza from your TV.

Business Themes

Complicated Transactions. Perhaps the craziest deal in John Malone’s years of experience in complex deal-making was his spinoff of Liberty Media. Liberty represented the content arm of TCI and held positions in famous channels like CNN and BET. Malone was intrigued at structuring a deal that would evade taxes and give himself the most potential upside. To create this “artificial” upside, Malone engineered a rights offering, whereby existing TCI shareholders could purchase the right to swap 16 shares of TCI for 1 share of Liberty. Malone set the price to swap at a ridiculously high value of TCI shares - ~valuing Liberty at $300 per share. “It seemed like such a lopsided offer: 16 shares of TCI for just 1 share of Liberty? That valued Liberty at $3000 a share, for a total market value of more than $600M by Malone’s reckoning. How could that be, analysts asked, given that Liberty posed a loss on revenue fo a mere $52M for the pro-forma nine months? No one on Wall Street expected the stock to trade up to $300 anytime soon.” The complexity of the rights offering + spinoff made the transaction opaque enough that even seasoned investors were confused about how it all worked and declined to buy the rights. This deal meant Malone would have more control of the newly separate Liberty Media. At the same time, the stock spin had such low participation that shares were initially thinly traded. Once people realized the quality of the company’s assets, the stock price shot up, along with Malone’s net worth. Even crazier, Malone took a loan from the new Liberty Media to buy shares of the company, meaning he had just created a massive amount of value by putting up hardly any capital. For a man that loved complex deals, this deal is one of his most complex and most lucrative.
Deal Maker Extraordinaire / Levered Rollups. John Malone and TCI loved deals and hated taxes. When TCI was building out cable networks, they acquired a new cable system almost every two weeks. Malone popularized using EBITDA (earnings before interest, taxes, depreciation, and amortization) as a proxy for real cash flow relative to net income, which incorporates tax and interest payments. To Malone, debt could be used for acquisitions to limit paying taxes and build scale. Once banks got comfortable with EBITDA, Malone went on an acquisition tear. “From 1984 to 1987, Malone had spent nearly $3B for more than 150 cable companies, placing TCI wires into one out of nearly every five with cable in the country, a penetration that was twice that of its next largest rival.” Throughout his career, he rallied many different cable leaders to find a deal that worked for everyone. In 1986, when fellow industry titan Ted Turner ran into financial trouble, Malone reached out to Viacom leader Sumner Redstone, to avoid letting Time Inc (owner of HBO) buy Turner’s CNN. After a quick negotiation, 31 cable operators agreed to rescue Turner Broadcasting with a $550M investment, allowing Turner to maintain control and avoid a takeover. Later, Malone led an industry consortium that included TCI, Comcast, and Cox to create a high speed internet service called, At Home, in 1996. “At Home was responsible for designing the high-speed network and providing services such as e-mail, and a home page featuring news, entertainment, sports, and chat groups. Cable operators were required to upgrade their local systems to accommodate two-way transmission, as well as handle marketing, billing, and customer complaints, for which they would get 65% of the revenue.” At Home ended up buying early internet search company Excite in a famous $7.5B deal, that diluted cable owners and eventually led to bankruptcy for the combined companies. Malone’s instinct was always to try his best to work with a counterparty because he genuinely believed a deal between two competitors provided better outcomes to everyone.
Tracking Stocks. Malone popularized the use of tracking stocks, which are publicly traded companies that mirror the operating performance of the underlying asset owned by a company. John Malone loved tracking stocks because they could be used to issue equity to finance operations and give investors access to specific divisions of a conglomerate while allowing the parent to maintain full control. While tracking stocks have been out of favor (except for Liberty Media, LOL), they were once highly regarded and even featured in the original planning of AT&T’s $48B purchase of TCI in 1998. AT&T financed its TCI acquisition with debt and new AT&T stock, diluting existing shareholders. AT&T CEO Michael Armstrong had initially agreed to use tracking stocks to separate TCI’s business from the declining but cash-flowing telephone business but changed his mind after AT&T’s stock rocketed following the TCI deal announcement. Malone was angry with Armstrong’s actions, and the book includes an explanation: “heres why you should mess with it, Mike: You’ve just issued more than 400 million new shares of AT&T to buy a business that produces no earnings. It will be a huge money-loser for years, given how much you’ll spend on broadband. That’s going to sharply dilute your earnings per share, and your old shareholders like earnings. That will hurt your stock price, and then you can’t use stock to make more acquisitions, then you’re stuck. If you create a tracking stock to the performance of cable, you separate out the losses we produce and show better earnings for your main shareholders; and you can use the tracker to buy more cable interests in tax-free deals.” Tracking stocks all but faded from existence following the internet bubble and early 2000s due to their difficulty of implementation and complexity, which can confuse shareholders and cause the businesses to trade at a large discount. This all begs the question, though - which companies could use tracking stock today? Imagine an AWS tracker, a Youtube tracker, an Instagram tracker, or an Xbox tracker - all of these could allow cloud companies to attract new shareholders, do more specific tax-free mergers, and raise additional capital specific to a business unit.

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January 2022 - Seven Powers by Hamilton Helmer

This month we dove into a classic technology strategy book. The book covers seven major Powers a company can have that offer both a benefit and a barrier to competition. Helmer covers the majority of the book through the lens of different case studies including his favorite company, Netflix.

Tech Themes

Power. After years as a consultant at BCG and decades investing in the public market, Helmer distilled all successful business strategies to seven individual Powers. A Power offers a company a re-inforcing benefit while also providing a barrier to potential competition. This is the epitome of an enduring business model in Helmer's mind. Power describes a company's strength relative to a specific competitor, and Powers focus on a single business unit rather than throughout a business. This makes sense: Apple may have a scale economies Power from its iPhone install base relative to Samsung, but it may not have Power in its AppleTV originals segment relative to Netflix. The seven types of Powers are: Scale Economies, Network Economies, Counter-Positioning, Switching Costs, Branding, Cornered Resources, and Process Power.
Invention. While Powers are somewhat easy to spot (scale economies of Google's search algorithm), creating them is anything but easy. So what underlies every one of the seven Powers? Invention. Helmer pulls invention through the lens of industry Dynamics - external competitive conditions and the forward march of technology create opportunities to pursue new business models, processes, brands, and products. Companies must leverage their resources to craft Powers through trial and error, rather than an upfront conscious decision to pursue something by design. I view this almost as an extension of Clayton Christensen's Resource-Processes-Values (RPV) framework we discussed in July 2020. Companies can find a route to Power through these resources and the crafting process. For Netflix, the route was streaming, but the actual Power came from a strong push into exclusive and original content. The streaming business opened up Netflix's subscriber base, and the content decision provided the ability to amortize great content across its growing subscriber base.
Power Progressions. Powers become available at different points in business progression. This makes sense - what drives a company forward in an unpenetrated market is different from what keeps it going during steady-state - Snowflake's competitive dynamics are different than Nestle's. Helmer defines three stages to a company: Origination, Takeoff, and Stability. These stages mirror the dynamics of S-Curves, which we discussed in our July 2021 book. During the Origination stage, companies can benefit from Cornered Resources and Counter-Positioning. Helmer uses the Pixar management team as an example of Cornered Resources during the Origination phase of 3D animated movies. The company had Steve Jobs (product visionary), John Lasseter (story-teller creative), and Ed Catmull (operations and technology leader). During the early days of the industry, these were the only people that knew how to operate a digital film studio. Another Cornered Resource example might be a company finding a new oil well. Before the company starts drilling, it is the only one that can own that asset. An example of Origination Counter-Positioning might be TSMC when they first launched. At that time, it was standard industry perception that semiconductor companies had to be integrated design manufacturers (IDM) - they had to do everything in-house. TSMC was launched as solely a fabrication facility that companies could use to gain extra manufacturing capacity or try out new designs. This gave them great Counter-Positioning relative to the IDM's and they were dismissed as a non-threat. The Takeoff period offers Network Economies, Scale Economies, and Switching Cost Powers. This phase is the growth phase of businesses. Snowflake currently benefits from Switching Cost dynamics - once you use Snowflake, it's unlikely you'll want to use other data warehouse providers because that process involves data replication and additional costs. Scale economies can be seen in businesses that amortize high costs over their user base, like Amazon. Amazon invests in distribution centers at a significant scale, which improves customer experience, which helps them get more customers - the flywheel repeats, allowing Amazon to continually invest in more distribution centers, further building its scale. Network economies show in social media businesses like Bytedance/TikTok. Users make content that attracts more users; incremental users join the platform because there is so much content to "gain" by joining the platform. Like scale economies, it's almost impossible to go build a competitor because a new company would have to recruit all users from the other platform, which would cost tons of money. The Stability phase offers Branding and Process Power. Branding is hard to generate, but the advantage grows with time. Consider luxury goods providers like LVMH; the older, the more exclusive the brand, the more it's desired, and every day it gets older and becomes more desired. A business can create Process Power by refining and improving operations to such a high degree that it becomes difficult to replicate. Classic examples of Process Power are TSMC's innovative 3-5nm processes today and Toyota's Production System. Toyota has even allowed competitors to tour its factory, but no competitor has replicated its operational efficiency.

Business Themes

Sneak Attack. I've always been surprised by businesses that seemingly "come out of nowhere." In Helmer's eyes, this stems from Counter-Positioning. He tells the story of Vanguard, which was started by Jack Bogle in 1976. "You could charitably describe the reception as enthusiastic: only $11M trickled in from investors. Soon after the launch, [Noble Laureate Paul] Samuelson himself lauded the effort in his column for Newsweek, but with little result: the fund had only reached $17M by mid-1977. Vanguard's operating model depended on others for distribution, and brokers, in particular, were put off by a product that predicated on the notion that they provided no value in helping their clients choose which active funds to select." But Vanguard had something that active managers didn't: low fees and consistency. Vanguard's funds performed like the indices and cost much less than active funds. No longer were individuals underperforming the market and paying advisors to pick actively managed funds. Furthermore, Vanguard continually invested all profits back into its funds, so it looked like it wasn't making money while it grew its assets under management. It's so hard to spot these sneak attacks while they are happening. But one that might be happening right now is Cloudflare relative to AWS. Cloudflare launched its low-cost R2 service (a play on Amazon's famous S3 storage technology). Cloudflare is offering a cheaper product at a much lower cost and is leveraging its large installed base with its CDN product to get people in the door. It's unclear whether this will offer Power over AWS because it's confusing what the barrier might be other than some relating to switching costs. However, there will likely be reluctance on AWS's part to cut prices because of its scale and public company growth targets.
A New Valuation Formula. Helmer offers a very unique take on the traditional DCF valuation approach. Investors have long suggested the value of any business was equal to the present value of its future discounted cash flows. In contrast to the traditional approach of summing up a firm's cash flows and discounting it, Helmer takes a look at all of the cash flows subject to the industry in which firms compete. In this formula (shown above), M0 represents the current market size, g the discounted market growth factor, s the long-term market share of the company, and m the long-term differential margin (net profit margin over that needed to cover the cost of capital). More simply, a company is worth it's Market Scale (Mo x g) x its Power (s x m). This implies that a company is worth the portion of the industry's profits it collects over time. This formula helps consider Power progression relative to industry dynamics and company stage. In the Origination stage, an industry's profits may be small but growing very quickly. If we think that a competitor in the industry can achieve an actual Power, it will likely gain a large portion of the long-term market. Thus, watching market share dynamics unfold can tell us about the potential for a route to Power and the ability for a company to achieve a superior value to its near-term cash flows.
Collateral Damage. If companies are aware of these Powers and how other companies can achieve them, how can companies not take proactive action to avoid being on the losing end of a Power struggle? Helmer lays out what he calls Collateral Damage, or the unwillingness of a competitor to find the right path to navigating the damage caused by a competitor's Power. His point is actually very nuanced - it's not the incumbent's unwillingness to invest in the same type of solution as the competitor (although that happens). The incumbent's business gets trashed as collateral damage by the new entrant. The incumbent can respond to the challenger by investing in the new innovation. But where counter-positioning really takes hold is if the incumbent recognizes the attractiveness of the business model/innovation but is stymied from investing. Why would a business leader choose not to invest in something attractive? In the case of Vanguard competitor Fidelity, any move into passive funds could cause steep cannibalization of their revenue. So in response, a CEO might decide to just keep their existing business and "milk" all of its cash flow. In addition, how could Fidelity invest in a business that completely undermined their actively managed mutual fund business? Often CEOs will have a negative bias toward the competing business model despite the positive NPV of an investment in the new business. Just think how long it took SAP to start selling Cloud subscriptions compared to its on-premise license/maintenance model. Lastly, a CEO might not invest in the promising new business model if they are worried about job security. This is the classic example of the principal-agent problem we discussed in June. Would you invest in a new, unproven business model if you faced a declining stock price and calls for your resignation? In addition, annual CEO compensation is frequently tagged to stock price performance and growth targets. The easiest way to achieve near-term stock price appreciation and growth targets is staying with what has worked in the past (and M&A!). Its the path of least resistance! Counter-positioning and collateral damage are nuanced and difficult to spot, but the complex emotions and issues become obvious over time.