Hi Spain, does it ring a bell?

Spanish pre minister Mariano Rajoy remains struggling to overcome the financial deficit with stronger austerity measures to keep up with the commitments with the EZ. Mean while Standard poor’s has cut Spain by two notches, to BBB- from BBB+, just one notch above junk level. Spokesman from S&P states “In our view, the capacity of Spain’s political institutions (both domestic and multilateral) to deal with the severe challenges posed by the current economic and financial crisis is declining, and therefore, in accordance with our rating methodology” 

The question that comes to mind is, seeing how influential this rankings are across the globe, when is the EU finally planning to have its own credit rating agency?

In order to replace “unsolicited” sovereign debt ratings of EU Member States with ratings by an independent body, reduce reliance on agency ratings, and eliminate conflicts of interest that could influence them. This discussion is worth a whole new post… I will leave it here for now.

We all know that Spain will eventually take on the bailout in the next days… the big and most concerning question is how will Spain wisely distribute this money? All looks like spain will inject this money to the banking system to  boost confidence more convincingly. My biggest concern is that the fact that Spain will get money back flowing is not the ultimate solution of all problems ahead. This might help generate confidence, so make investors feel safer, but this only benefits Spain in the short run, Spain needs a inside domestic product that is being generate by the country’s resources, to claim up on revenue and decrease the high unemployment figures. They can just ignore the fact that at its peak the property bubble had expanded at a massive 16% of their GDP, and employed a total of 12% of the active population. This financial gap needs to be covered, and certainly it will just not happen by raising the austerity measures that are destroying Spanish welfare state as we know it.

Spain needs to look for long-term solutions to its economic problems, needs to invest more in innovation and in making Spanish revenue grow from other than Tax payers and Tapas. “Instead of changing the world through revolution, we can change the world through innovation!”  That’s what they say in Chile in the so called “Chilicon Valley” project.

Start-Up Chile is a program of the Chilean Government to attract world-class early stage entrepreneurs to start their businesses in Chile.

Start-Up Chile” is the brainchild of Nicolas Shea, a Chilean businessman who had a brief stint in government. The programme selects promising young firms and gives their founders the equivalent of $40,000 and a year’s visa to come and work on their ideas in Chile. Since 2010, when Start-Up Chile started, some 500 companies and almost 900 entrepreneurs from a total of 37 countries have taken part.

They are creating the perfect ecosystem for entrepreneurs to come and build it up, all this effort has a tremendous impact in the long term towards their economy, and might play a role on their GDP one day, and all this while keeping the unemployment rate low.

Spain needs to make the country more sexy and inviting for entrepreneurs, while also contenting its hyper-frustrated youth that can’t seem to believe in their country anymore. With the current picture most of the talented people with possibilities go get their shoot abroad leaving behind the country that educated and invested in their future skills to contribute to the country’s development.

Spain needs to get out of this negative-loop where is trapped, maybe as the Chilean say:

   “Instead of changing the world through revolution, we can change the world through   innovation!”

Q1 2012 saw the most tech IPOs in four years, but funding amounts are down…

The first quarter of 2012 was the best quarter in more than four years for software and Internet company IPOs, according to a new report.

But in the aftermath of Facebook’s much-hyped and problematic IPO, can the momentum continue?

Tech-focused Silicon Valley law firm Fenwick & West has released a report called “Trends in Terms of Venture Financings in Silicon Valley” for the first quarter of 2012. The report examined 114 companies headquartered in Silicon Valley that reported raising money in the quarter one 2012. It compiles funding and investment information from  Dow Jones VentureSource, Thomson Reuters, the National Venture Capital Association, and Fenwick & West’s Venture Capital Barometer.

By the end of the first quarter 2012, 50 Silicon Valley companies had registered to go public, more than in any quarter since Q4 2007. How many IPOs happened and how much money they raised depends on which source you rely on:

  • VentureSource reported 20 venture-backed IPOs collectively raised $1.4 billion in Q1 2012, compared to 10 IPOs raising $2.4 billion in the Q4 2011.
  • Thomson Reuters and the NVCA reported 19 IPOs raising $1.5 billion in Q1 2012, compared to 12 IPOs raising $2.6 billion in Q4 2011.

During the first quarter, up rounds (a round where a company receives money at a higher valuation than it got during its last round) exceeded down rounds (a round where the company’s valuation decreases) by 65 percent to 22 percent. Thirteen percent of rounds were flat, with no valuation changes. This is slightly down from the fourth quarter of 2011, when up rounds made up 70 percent of funding.

Q1 2012 is the eleventh consecutive quarter where up rounds exceeded down rounds, according to the report. That means investors are gaining more confidence in the technology industry, prompting them to invest at higher valuations.

“The first quarter of 2012 was a mixed quarter for the venture capital industry, with venture valuations healthy but venture investment down, M&A valuations up but the number of deals down, venture fundraising mixed but corporate venture investing up, and IPOs and Nasdaq up, but Nasdaq down in the second quarter to date and global financial uncertainty continuing to be a problem”, said Fenwick and West partner, and co-author of the report, Michael Patrick.

However, while the number of IPOs was up, the overall amounts of venture capital investments were down in the first quarter:

  • Dow Jones VentureSource reported $6.2 billion in 717 deals in Q1, down 16 percent from 2011′s first quarter.
  • Thomson Reuters and the NVCA reported $5.8 billion of funding in 758 deals in Q1, with a 12 percent decline over last year.

The biggest issues moving forward is venture capital fundraising, according to the report. As VC firms struggle to raise money for their funds, venture capital investments decline. There were conflicting reports on VC fundraising:  Thomson and the NVCA reported a 13 percent decrease from Q4 2011 and Dow Jones reported a 35 percent increase over the same time frame.

Strong first-quarter IPOs may help the market in the near future. Mobile, cloud, security, big data and social media have attracted attention and funding, which according to the report won’t change anytime soon. But the longer-term prospects for IPOs may be hurt if venture capital firms have trouble raising money for their funds, or invest less in the startups that will eventually become future IPOs.

What is Debt? – An Interview with Economic Anthropologist David Graeber

David Graeber currently holds the position of Reader in Social Anthropology at Goldsmiths University London. Prior to this he was an associate professor of anthropology at Yale University. He is the author of ‘Debt: The First 5,000 Years’ which is available from Amazon.

Interview conducted by Philip Pilkington, a journalist and writer based in Dublin, Ireland.

Philip Pilkington: Let’s begin. Most economists claim that money was invented to replace the barter system. But you’ve found something quite different, am I correct?

David Graeber: Yes there’s a standard story we’re all taught, a ‘once upon a time’ — it’s a fairy tale.

It really deserves no other introduction: according to this theory all transactions were by barter. “Tell you what, I’ll give you twenty chickens for that cow.” Or three arrow-heads for that beaver pelt or what-have-you. This created inconveniences, because maybe your neighbor doesn’t need chickens right now, so you have to invent money.

The story goes back at least to Adam Smith and in its own way it’s the founding myth of economics. Now, I’m an anthropologist and we anthropologists have long known this is a myth simply because if there were places where everyday transactions took the form of: “I’ll give you twenty chickens for that cow,” we’d have found one or two by now. After all people have been looking since 1776, when the Wealth of Nations first came out. But if you think about it for just a second, it’s hardly surprising that we haven’t found anything.

Think about what they’re saying here – basically: that a bunch of Neolithic farmers in a village somewhere, or Native Americans or whatever, will be engaging in transactions only through the spot trade. So, if your neighbor doesn’t have what you want right now, no big deal. Obviously what would really happen, and this is what anthropologists observe when neighbors do engage in something like exchange with each other, if you want your neighbor’s cow, you’d say, “wow, nice cow” and he’d say “you like it? Take it!” – and now you owe him one. Quite often people don’t even engage in exchange at all – if they were real Iroquois or other Native Americans, for example, all such things would probably be allocated by women’s councils.

So the real question is not how does barter generate some sort of medium of exchange, that then becomes money, but rather, how does that broad sense of ‘I owe you one’ turn into a precise system of measurement – that is: money as a unit of account?

By the time the curtain goes up on the historical record in ancient Mesopotamia, around 3200 BC, it’s already happened. There’s an elaborate system of money of account and complex credit systems. (Money as medium of exchange or as a standardized circulating units of gold, silver, bronze or whatever, only comes much later.)

So really, rather than the standard story – first there’s barter, then money, then finally credit comes out of that – if anything its precisely the other way around. Credit and debt comes first, then coinage emerges thousands of years later and then, when you do find “I’ll give you twenty chickens for that cow” type of barter systems, it’s usually when there used to be cash markets, but for some reason – as in Russia, for example, in 1998 – the currency collapses or disappears.

PP: You say that by the time historical records start to be written in the Mesopotamia around 3200 BC a complex financial architecture is already in place. At the same time is society divided into classes of debtors and creditors? If not then when does this occur? And do you see this as the most fundamental class division in human history?

DG: Well historically, there seem to have been two possibilities.

One is what you found in Egypt: a strong centralized state and administration extracting taxes from everyone else. For most of Egyptian history they never developed the habit of lending money at interest. Presumably, they didn’t have to.

Mesopotamia was different because the state emerged unevenly and incompletely. At first there were giant bureaucratic temples, then also palace complexes, but they weren’t exactly governments and they didn’t extract direct taxes – these were considered appropriate only for conquered populations. Rather they were huge industrial complexes with their own land, flocks and factories. This is where money begins as a unit of account; it’s used for allocating resources within these complexes.

Interest-bearing loans, in turn, probably originated in deals between the administrators and merchants who carried, say, the woollen goods produced in temple factories (which in the very earliest period were at least partly charitable enterprises, homes for orphans, refugees or disabled people for instance) and traded them to faraway lands for metal, timber, or lapis lazuli. The first markets form on the fringes of these complexes and appear to operate largely on credit, using the temples’ units of account. But this gave the merchants and temple administrators and other well-off types the opportunity to make consumer loans to farmers, and then, if say the harvest was bad, everybody would start falling into debt-traps.

This was the great social evil of antiquity – families would have to start pawning off their flocks, fields and before long, their wives and children would be taken off into debt peonage. Often people would start abandoning the cities entirely, joining semi-nomadic bands, threatening to come back in force and overturn the existing order entirely. Rulers would regularly conclude the only way to prevent complete social breakdown was to declare a clean slate or ‘washing of the tablets,’ they’d cancel all consumer debt and just start over. In fact, the first recorded word for ‘freedom’ in any human language is the Sumerian amargi, a word for debt-freedom, and by extension freedom more generally, which literally means ‘return to mother,’ since when they declared a clean slate, all the debt peons would get to go home.

PP: You have noted in the book that debt is a moral concept long before it becomes an economic concept. You’ve also noted that it is a very ambivalent moral concept insofar as it can be both positive and negative. Could you please talk about this a little? Which aspect is more prominent?

DG: Well it tends to pivot radically back and forth.

One could tell the history like this: eventually the Egyptian approach (taxes) and Mesopotamian approach (usury) fuse together, people have to borrow to pay their taxes and debt becomes institutionalized.

Taxes are also key to creating the first markets that operate on cash, since coinage seems to be invented or at least widely popularized to pay soldiers – more or less simultaneously in China, India, and the Mediterranean, where governments find the easiest way to provision the troops is to issue them standard-issue bits of gold or silver and then demand everyone else in the kingdom give them one of those coins back again. Thus we find that the language of debt and the language of morality start to merge.

In Sanskrit, Hebrew, Aramaic, ‘debt,’ ‘guilt,’ and ‘sin’ are actually the same word. Much of the language of the great religious movements – reckoning, redemption, karmic accounting and the like – are drawn from the language of ancient finance. But that language is always found wanting and inadequate and twisted around into something completely different. It’s as if the great prophets and religious teachers had no choice but to start with that kind of language because it’s the language that existed at the time, but they only adopted it so as to turn it into its opposite: as a way of saying debts are not sacred, but forgiveness of debt, or the ability to wipe out debt, or to realize that debts aren’t real – these are the acts that are truly sacred.

How did this happen? Well, remember I said that the big question in the origins of money is how a sense of obligation – an ‘I owe you one’ – turns into something that can be precisely quantified? Well, the answer seems to be: when there is a potential for violence. If you give someone a pig and they give you a few chickens back you might think they’re a cheapskate, and mock them, but you’re unlikely to come up with a mathematical formula for exactly how cheap you think they are. If someone pokes out your eye in a fight, or kills your brother, that’s when you start saying, “traditional compensation is exactly twenty-seven heifers of the finest quality and if they’re not of the finest quality, this means war!”

Money, in the sense of exact equivalents, seems to emerge from situations like that, but also, war and plunder, the disposal of loot, slavery. In early Medieval Ireland, for example, slave-girls were the highest denomination of currency. And you could specify the exact value of everything in a typical house even though very few of those items were available for sale anywhere because they were used to pay fines or damages if someone broke them.

But once you understand that taxes and money largely begin with war it becomes easier to see what really happened. After all, every Mafiosi understands this. If you want to take a relation of violent extortion, sheer power, and turn it into something moral, and most of all, make it seem like the victims are to blame, you turn it into a relation of debt. “You owe me, but I’ll cut you a break for now…” Most human beings in history have probably been told this by their debtors. And the crucial thing is: what possible reply can you make but, “wait a minute, who owes what to who here?” And of course for thousands of years, that’s what the victims have said, but the moment you do, you are using the rulers’ language, you’re admitting that debt and morality really are the same thing. That’s the situation the religious thinkers were stuck with, so they started with the language of debt, and then they tried to turn it around and make it into something else.

PP: You’d be forgiven for thinking this was all very Nietzschean. In his ‘On the Genealogy of Morals’ the German philosopher Friedrich Nietzsche famously argued that all morality was founded upon the extraction of debt under the threat of violence. The sense of obligation instilled in the debtor was, for Nietzsche, the origin of civilisation itself. You’ve been studying how morality and debt intertwine in great detail. How does Nietzsche’s argument look after over 100 years? And which do you see as primal: morality or debt?

DG: Well, to be honest, I’ve never been sure if Nietzsche was really serious in that passage or whether the whole argument is a way of annoying his bourgeois audience; a way of pointing out that if you start from existing bourgeois premises about human nature you logically end up in just the place that would make most of that audience most uncomfortable.
In fact, Nietzsche begins his argument from exactly the same place as Adam Smith: human beings are rational. But rational here means calculation, exchange and hence, trucking and bartering; buying and selling is then the first expression of human thought and is prior to any sort of social relations.

But then he reveals exactly why Adam Smith had to pretend that Neolithic villagers would be making transactions through the spot trade. Because if we have no prior moral relations with each other, and morality just emerges from exchange, then ongoing social relations between two people will only exist if the exchange is incomplete – if someone hasn’t paid up.

But in that case, one of the parties is a criminal, a deadbeat and justice would have to begin with the vindictive punishment of such deadbeats. Thus he says all those law codes where it says ‘twenty heifers for a gouged-out eye’ – really, originally, it was the other way around. If you owe someone twenty heifers and don’t pay they gouge out your eye. Morality begins with Shylock’s pound of flesh.
Needless to say there’s zero evidence for any of this – Nietzsche just completely made it up. The question is whether even he believed it. Maybe I’m an optimist, but I prefer to think he didn’t.

Anyway it only makes sense if you assume those premises; that all human interaction is exchange, and therefore, all ongoing relations are debts. This flies in the face of everything we actually know or experience of human life. But once you start thinking that the market is the model for all human behavior, that’s where you end up with.

If however you ditch the whole myth of barter, and start with a community where people do have prior moral relations, and then ask, how do those moral relations come to be framed as ‘debts’ – that is, as something precisely quantified, impersonal, and therefore, transferrable – well, that’s an entirely different question. In that case, yes, you do have to start with the role of violence.

PP: Interesting. Perhaps this is a good place to ask you about how you conceive your work on debt in relation to the great French anthropologist Marcel Mauss’ classic work on gift exchange.

DG: Oh, in my own way I think of myself as working very much in the Maussian tradition. Mauss was one of the first anthropologists to ask: well, all right, if not barter, then what? What do people who don’t use money actually do when things change hands? Anthropologists had documented an endless variety of such economic systems, but hadn’t really worked out common principles. What Mauss noticed was that in almost all of them, everyone pretended as if they were just giving one another gifts and then they fervently denied they expected anything back. But in actual fact everyone understood there were implicit rules and recipients would feel compelled to make some sort of return.

What fascinated Mauss was that this seemed to be universally true, even today. If I take a free-market economist out to dinner he’ll feel like he should return the favor and take me out to dinner later. He might even think that he is something of chump if he doesn’t and this even if his theory tells him he just got something for nothing and should be happy about it. Why is that? What is this force that compels me to want to return a gift?

This is an important argument, and it shows there is always a certain morality underlying what we call economic life. But it strikes me that if you focus too much on just that one aspect of Mauss’ argument you end up reducing everything to exchange again, with the proviso that some people are pretending they aren’t doing that.

Mauss didn’t really think of everything in terms of exchange; this becomes clear if you read his other writings besides ‘The Gift’. Mauss insisted there were lots of different principles at play besides reciprocity in any society – including our own.

For example, take hierarchy. Gifts given to inferiors or superiors don’t have to be repaid at all. If another professor takes our economist out to dinner, sure, he’ll feel that he should reciprocate; but if an eager grad student does, he’ll probably figure just accepting the invitation is favor enough; and if George Soros buys him dinner, then great, he did get something for nothing after all. In explicitly unequal relations, if you give somebody something, far from doing you a favor back, they’re more likely to expect you to do it again.

Or take communistic relations – and I define this, following Mauss actually, as any ones where people interact on the basis of ‘from each according to their abilities to each according to their needs’. In these relations people do not rely on reciprocity, for example, when trying to solve a problem, even inside a capitalist firm. (As I always say, if somebody working for Exxon says, “hand me the screwdriver,” the other guy doesn’t say, “yeah and what do I get for it?”) Communism is in a way the basis of all social relations – in that if the need is great enough (I’m drowning) or the cost small enough (can I have a light?) everyone will be expected to act that way.

Anyway that’s one thing I got from Mauss. There are always going to be lots of different sorts of principles at play simultaneously in any social or economic system – which is why we can never really boil these things down to a science. Economics tries to, but it does it by ignoring everything except exchange.

PP: Let’s move onto economic theory then. Economics has some pretty specific theories about what money is. There’s the mainstream approach that we discussed briefly above; this is the commodity theory of money in which specific commodities come to serve as a medium of exchange to replace crude barter economies. But there’s also alternative theories that are becoming increasingly popular at the moment. One is the Circuitist theory of money in which all money is seen as a debt incurred by some economic agent. The other – which actually integrates the Circuitist approach – is the Chartalist theory of money in which all money is seen as a medium of exchange issued by the Sovereign and backed by the enforcement of tax claims. Maybe you could say something about these theories?

DG: One of my inspirations for ‘Debt: The First 5,000 Years’ was Keith Hart’s essay ‘Two Sides of the Coin’. In that essay Hart points out that not only do different schools of economics have different theories on the nature of money, but there is also reason to believe that both are right. Money has, for most of its history, been a strange hybrid entity that takes on aspects of both commodity (object) and credit (social relation.) What I think I’ve managed to add to that is the historical realization that while money has always been both, it swings back and forth – there are periods where credit is primary, and everyone adopts more or less Chartalist theories of money and others where cash tends to predominate and commodity theories of money instead come to the fore. We tend to forget that in, say, the Middle Ages, from France to China, Chartalism was just common sense: money was just a social convention; in practice, it was whatever the king was willing to accept in taxes.

PP: You say that history swings between periods of commodity money and periods of virtual money. Do you not think that we’ve reached a point in history where due to technological and cultural evolution we may have seen the end of commodity money forever?

DG: Well, the cycles are getting a bit tighter as time goes by. But I think we’ll still have to wait at least 400 years to really find out. It is possible that this era is coming to an end but what I’m more concerned with now is the period of transition.

The last time we saw a broad shift from commodity money to credit money it wasn’t a very pretty sight. To name a few we had the fall of the Roman Empire, the Kali Age in India and the breakdown of the Han dynasty… There was a lot of death, catastrophe and mayhem. The final outcome was in many ways profoundly libratory for the bulk of those who lived through it – chattel slavery, for example, was largely eliminated from the great civilizations. This was a remarkable historical achievement. The decline of cities actually meant most people worked far less. But still, one does rather hope the dislocation won’t be quite so epic in its scale this time around. Especially since the actual means of destruction are so much greater this time around.

PP: Which do you see as playing a more important role in human history: money or debt?

DG: Well, it depends on your definitions. If you define money in the broadest sense, as any unit of account whereby you can say 10 of these are worth 7 of those, then you can’t have debt without money. Debt is just a promise that can be quantified by means of money (and therefore, becomes impersonal, and therefore, transferable.) But if you are asking which has been the more important form of money, credit or coin, then probably I would have to say credit.

PP: Let’s move on to some of the real world problems facing the world today. We know that in many Western countries over the past few years households have been running up enormous debts, from credit card debts to mortgages (the latter of which were one of the root causes of the recent financial crisis). Some economists are saying that economic growth since the Clinton era was essentially run on an unsustainable inflating of household debt. From an historical perspective what do you make of this phenomenon?

DG: From an historical perspective, it’s pretty ominous. One could go further than the Clinton era, actually – a case could be made that we are seeing now is the same crisis we were facing in the 70s; it’s just that we managed to fend it off for 30 or 35 years through all these elaborate credit arrangements (and of course, the super-exploitation of the global South, through the ‘Third World Debt Crisis’.)

As I said Eurasian history, taken in its broadest contours, shifts back and forth between periods dominated by virtual credit money and those dominated by actual coin and bullion. The credit systems of the ancient Near East give way to the great slave-holding empires of the Classical world in Europe, India, and China, which used coinage to pay their troops. In the Middle Ages the empires go and so does the coinage – the gold and silver is mostly locked up in temples and monasteries – and the world reverts to credit. Then after 1492 or so you have the return world empires again; and gold and silver currency together with slavery, for that matter.

What’s been happening since Nixon went off the gold standard in 1971 has just been another turn of the wheel – though of course it never happens the same way twice. However, in one sense, I think we’ve been going about things backwards. In the past, periods dominated by virtual credit money have also been periods where there have been social protections for debtors. Once you recognize that money is just a social construct, a credit, an IOU, then first of all what is to stop people from generating it endlessly? And how do you prevent the poor from falling into debt traps and becoming effectively enslaved to the rich? That’s why you had Mesopotamian clean slates, Biblical Jubilees, Medieval laws against usury in both Christianity and Islam and so on and so forth.

Since antiquity the worst-case scenario that everyone felt would lead to total social breakdown was a major debt crisis; ordinary people would become so indebted to the top one or two percent of the population that they would start selling family members into slavery, or eventually, even themselves.

Well, what happened this time around? Instead of creating some sort of overarching institution to protect debtors, they create these grandiose, world-scale institutions like the IMF or S&P to protect creditors. They essentially declare (in defiance of all traditional economic logic) that no debtor should ever be allowed to default. Needless to say the result is catastrophic. We are experiencing something that to me, at least, looks exactly like what the ancients were most afraid of: a population of debtors skating at the edge of disaster.

And, I might add, if Aristotle were around today, I very much doubt he would think that the distinction between renting yourself or members of your family out to work and selling yourself or members of your family to work was more than a legal nicety. He’d probably conclude that most Americans were, for all intents and purposes, slaves.

PP: You mention that the IMF and S&P are institutions that are mainly geared toward extracting debts for creditors. This seems to have become the case in the European monetary union too. What do you make of the situation in Europe at the moment?

DG: Well, I think this is a prime example of why existing arrangements are clearly untenable. Obviously the ‘whole debt’ cannot be paid. But even when some French banks offered voluntary write-downs for Greece, the others insisted they would treat it as if it were a default anyway. The UK takes the even weirder position that this is true even of debts the government owes to banks that have been nationalized – that is, technically, that they owe to themselves! If that means that disabled pensioners are no longer able to use public transit or youth centers have to be closed down, well that’s simply the ‘reality of the situation,’ as they put it.

These ‘realities’ are being increasingly revealed to simply be ones of power. Clearly any pretence that markets maintain themselves, that debts always have to be honored, went by the boards in 2008. That’s one of the reasons I think you see the beginnings of a reaction in a remarkably similar form to what we saw during the heyday of the ‘Third World debt crisis’ – what got called, rather weirdly, the ‘anti-globalization movement’. This movement called for genuine democracy and actually tried to practice forms of direct, horizontal democracy. In the face of this there was the insidious alliance between financial elites and global bureaucrats (whether the IMF, World Bank, WTO, now EU, or what-have-you).

When thousands of people begin assembling in squares in Greece and Spain calling for real democracy what they are effectively saying is: “Look, in 2008 you let the cat out of the bag. If money really is just a social construct now, a promise, a set of IOUs and even trillions of debts can be made to vanish if sufficiently powerful players demand it then, if democracy is to mean anything, it means that everyone gets to weigh in on the process of how these promises are made and renegotiated.” I find this extraordinarily hopeful.

PP: Broadly speaking how do you see the present debt/financial crisis unravelling? Without asking you to peer into the proverbial crystal-ball – because that’s a silly thing to ask of anyone – how do you see the future unfolding; in the sense of how do you take your bearings right now?

DG: For the long-term future, I’m pretty optimistic. We might have been doing things backwards for the last 40 years, but in terms of 500-year cycles, well, 40 years is nothing. Eventually there will have to be recognition that in a phase of virtual money, safeguards have to be put in place – and not just ones to protect creditors. How many disasters it will take to get there? I can’t say.

But in the meantime there is another question to be asked: once we do these reforms, will the results be something that could even be called ‘capitalism’?

Read more at http://www.nakedcapitalism.com/2011/08/what-is-debt-%E2%80%93-an-interview-with-economic-anthropologist-david-graeber.html#Xhy0Rd8u5vrsXfww.99

CS183: Startup— Notes Essay —Value Systems

Thanks to blakmaster from now every Friday I will be sharing with you Peter Thiel’s Startup Classes he is teaching in the US.

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CS183: Startup—Notes Essay—Value Systems

 The history of the ‘90s was in many ways the history of widespread confusion about the question of value. Valuations were psychosocial; value was driven by what people said it was. To avoid herd-like confusion of decades past, we need to try and figure out whether it’s possible to determine businesses’ objective value and, if it is, how to do it.

As we discussed back in Class 1, certain questions and frameworks can anchor our thinking about value. The questions are necessarily personal: What can I do? What do I think is valuable? What do I see others not doing? A good framework might map globalization and technology as the two great axes of the 21st century. Synthesizing all this together forges the higher-level question: What valuable company is nobody building

A somewhat different perspective on technology—going from 0 to 1, to revisit our earlier terminology—is the financial or economic one. Since that perspective can also shed considerable light on the value question, it’s worth covering in detail now.

I. Great Technology Companies

Great companies do three things. First, they create value. Second, they are lasting or permanent in a meaningful way. Finally, they capture at least some of the value they create.

The first point is straightforward. Companies that don’t create value simply can’t be great. Creating value may not be sufficient for greatness, but it’s hard to see how it’s not at least necessary.

Great companies last. They are durable. They don’t create value and disappear very fast. Consider disk drive companies of the 1980s. They created a lot of value by making new and better drives. But the companies themselves didn’t last; they were all replaced by others. Not sticking around limits both the value you can create and the value you can capture.

Finally—and relatedly—you have to capture much of the value you create in order to be great. A scientist or mathematician may create a lot of lasting value with an important discovery. But capturing a meaningful piece of that value is another matter entirely. Sir Isaac Newton, for example, failed to capture much of the immense value that he created through his work. The airline industry is a less abstract example. The airlines certainly create value in that the public is much better off because they exist. And they employ tons of people. But the airlines themselves have never really made any money. Certainly some are better than others. But probably none can be considered a truly great company.

II. Valuation

One way that people try and objectively determine a company’s value is through multiples and comparables. This sort of works. But people should be on guard against social heuristics substituting for rigorous analysis, since analysis tends to be driven by standards and conventions that exist at the time. If you start a company at an incubator, certain conventions exist there. If everyone is investing at a $10M cap, the company might be deemed to be worth $10M. There are a bunch of formulas that incorporate metrics like monthly page views or number of active users that people use sometimes. Somewhat more rigorous are revenue multiples. Software companies are often valued at around 10x annual revenues. Guy Kawasaki has suggested a particularly unique (and possibly helpful) equation:

pre-money valuation = ($1M*n_engineers) – ($500k*n_MBAs).

The most common multiple is the price-earnings ratio, also known as P/E ratio or the PER. The PER is equal to market value (per share)  / earnings (per share). In other words, it is the price of a stock relative to a firm’s net income. The PER is widely used but does not account for growth.

To account for growth, you use the PEG, or Price/Earnings to Growth ratio. PEG equals (market value / earnings) / annual earnings growth. That is, PEG is PER divided by annual growth in earnings. The lower a company’s PEG ratio, the slower it’s growing and thus the less valuable it is. Higher PEG ratios tend to mean higher valuations. In any case, PEG should be less than one. The PEG is a good indicator to keep an eye on while growing your business.

One does valuation analysis at a given point in time. But that analysis factors in many points in time. You look not just at cash flows for the current year, but over future years as well. Sum all the numbers and you get the earnings value. But a quantity of money today is worth more than it is in the future. So you discount the time value of money, or TVM, since there are all sorts of risks as you move forward in the future. The basic math for TVM is:

       

Things are harder when cash flows aren’t constant. Here is the math for variable cash flows:

         

So to determine the value of a company, you do the applicable DPV or NPV calculation for the next X (or infinite) years. Generally, you want to be greater than r. Otherwise your company isn’t growing enough to keep up with the discount rate. Of course, in a growth model, the growth rate must eventually decline. Otherwise the company will approach infinite value over time—not likely. 

Valuations for Old Economy firms work differently. In businesses in decline, most of the value is in the near term. Value investors look at cash flows. If a company can maintain present cash flows for 5 or 6 years, it’s a good investment. Investors then just hope that those cash flows—and thus the company’s value—don’t decrease faster than they anticipate.

Tech and other high growth companies are different. At first, most of them losemoney. When the growth rate—g, in our calculations above—is higher than the discount rate r, a lot of the value in tech businesses exists pretty far in the future. Indeed, a typical model could see 2/3 of the value being created in years 10 through 15. This is counterintuitive. Most people—even people working in startups today—think in Old Economy mode where you have to create value right off the bat. The focus, particularly in companies with exploding growth, is on next months, quarters, or, less frequently, years. That is too short a timeline. Old Economy mode works in the Old Economy. It does not work for thinking about tech and high growth businesses. Yet startup culture today pointedly ignores, and even resists, 10-15 year thinking.

PayPal is illustrative. 27 months in, its growth rate was 100%. Everybody knew that rate would decelerate, but figured that it would still be higher than the discount rate. The plan was that most of the value would come around 2011. Even that long-term thinking turned out to undershoot; the discount rate has been lower than expected, and the growth rate is still at a healthy 15%. Now, it looks like most of PayPal’s value won’t come until in 2020.

LinkedIn is another good example of the importance of the long-term. Its market cap is currently around around $10B and it’s trading at a (very high) P/E of about 850. But discounted cash flow analysis makes LinkedIn’s valuation make sense; it’s expected to create around $2B in value between 2012 and 2019, while the other $8B reflects expectations about 2020 and beyond. LinkedIn’s valuation, in other words, only makes sense if there’s durability, i.e. if it’s around to create all that value in the decades to come.

III. Durability

People often talk about “first mover advantage.” But focusing on that may be problematic; you might move first and then fade away. The danger there is that you simply aren’t around to succeed, even if you do end up creating value. More important than being the first mover is being the last mover. You have to be durable. In this one particular at least, business is like chess. Grandmaster José Raúl Capablanca put it well: to succeed, “you must study the endgame before everything else.”

IV. Capturing Value

The basic economic ideas of supply and demand are useful in thinking about capturing value. The common insight is that market equilibrium is where supply and demand intersect. When you analyze a business under this framework, you get one of two options: perfect competition or monopoly.

In perfect competition, no firms in an industry make economic profit. If there are profits to be made, firms enter the market and the profits go away. If firms are suffering economic losses, some fold and exit. So you don’t make any money. And it’s not just you; no one makes any money. In perfect competition, the scale on which you’re operating is negligible compared to the scale of the market as a whole. You might be able to affect demand a little bit. But generally you’re a price taker. 

But if you’re a monopoly, you own the market. By definition, you’re the only one producing a certain thing. Most economics textbooks spend a great deal of time talking about perfect competition. They tend to treat monopoly as somehow being within, or as some small exception to perfect competition. The world, say these books, defaults to equilibrium.

But perhaps monopoly is not some strange exception. Perhaps perfect competition is only the default in economics textbooks. We should wonder whether monopoly is a valid alternative paradigm in its own right. Consider great tech companies. Most have one decisive advantage—such as economies of scale or uniquely low production costs—that make them at least monopoly-esque in some important way. A drug company, for instance, might secure patent protection for a certain drug, thus enabling it to charge more than its costs of production. The really valuable businesses are monopoly businesses. They are the last movers who create value that can be sustained over time instead of being eroded away by competitive forces.

V. The Ideology of Competition

A. PayPal and Competition

PayPal was in the payments business. There were considerable economies of scale in that business. You couldn’t compete with the big credit card companies directly; to compete, you had to undercut them in some way. PayPal tried to do that in two ways: through technical innovation and through product innovation.

The primary technical problem that PayPal faced was fraud. When Internet payments started to get going, there was much more fraud than people expected. Also unexpected was how hard it was to stamp it out. Enemies in the War on Fraud were many. There was “Carders World,” a dystopian web marketplace that vowed to bring down Western Capitalism by transacting in stolen identities. There was a particularly bothersome hacker named Igor, who evaded the FBI on jurisdictional technicalities. (Unrelatedly, Igor was later killed by the Russian mafia.) Ultimately, PayPal was able to develop really good software to get a handle on the fraud problem. The name of that software? “Igor.”

Another key innovation was making funding sources cheaper. Getting users’ bank account information drove down blended costs. By modeling how much money was in an account, PayPal could make advance payments, more or less circumvent the Automatic Clearing House system, and make payments instantaneous from the user’s perspective. 

These are just two examples from PayPal. Yours will look different. The takeaway is that it’s absolutely critical to have some decisive advantage over the next best service. Because even a small number of competing services quickly makes for a very competitive dynamic.

B. Competition and Monopoly

Whether competition is good or bad is an interesting (and usually overlooked) question. Most people just assume it’s good. The standard economic narrative, with all its focus on perfect competition, identifies competition as the source of all progress. If competition is good, then the default view on its opposite—monopoly—is that it must be very bad.  Indeed, Adam Smith adopted this view in The Wealth of Nations:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

This insight is important, if only because it’s so prevalent. But exactly why monopoly is bad is hard to tease out. It’s usually just accepted as a given. But it’s probably worth questioning in greater detail.

C. Testing for Monopoly

The Sherman Act declares: “The possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.” So in order to determine whether a monopoly is illegal or not, we just have to figure out what “anticompetitive conduct” means.

The DOJ has 3 tests for evaluating monopolies and monopoly pricing. First is the Lerner index, which gives a sense of how much market power a particular company has. The index value equals (price – marginal cost) / price. Index values range from 0 (perfect competition) to 1 (monopoly). The intuition that market power matters a lot is right. But in practice the Lerner index tends to be intractable with since you have to know market price and marginal cost schedules. But tech companies know their own information and should certainly pay attention to their Lerner index. 

Second is the Herfindahl-Hirschman index. It uses firm and industry size to gauge how much competition exists in an industry. Basically, you sum the squares of the top 50 firms’ market shares. The lower the index value, the more competitive the market. Values below 0.15 indicate a competitive market. Values from 0.15 to .25 indicate a concentrated market. Values higher than 0.25 indicate a highly concentrated and possibly monopolistic market. 

Finally, there is the m-firm concentration ratio. You take either the 4 or 8 largest firms in an industry and sum their market shares. If together they comprise more than 70% of the market, then that market is concentrated.

D. The Good and Bad of Monopoly

First, the cons: monopolies generally produce lower output and charge higher prices than firms in competitive markets do. This may not hold true for some natural monopolies. And some industries have monopolies of scale, which are a bit different. But monopolies generally get to be price setters, not price takers. There also might be price discrimination, since monopolists may capture more consumer surplus by charging different groups different prices. Another criticism is that monopoly stifles innovation; since it earns profits whether it innovates or not, a monopoly business might grow complacent and not develop any new technology.

But the innovation argument can go the other way too. Monopoly might net incentivize innovation. If a company creates something dramatically better than the next best thing, where’s the harm in allowing it to price it higher than its marginal cost of production? The delta is the creators’ reward for creating the new thing. Monopolistic firms can also conduct better long-term planning and take on deeper project financing, since there’s a sense of durability that wouldn’t exist in perfect competition where profits are zero.

E. Biases for Perfect Competition

An interesting question is why most people seem biased in favor of perfect competition. It’s hard to argue that economists don’t tend to idolize it. Indeed the very term “perfect competition” seems pregnant with some normative meaning. It’s not called “insane competition” or “ruthless competition.” That’s probably not an accident. Perfect competition, we’re told, is perfect. 

To start, perfect competition may be attractive because it’s easy to model. That probably explains a lot right there, since economics is all about modeling the world to make it easier to deal with. Perfect competition might also seem to make sense because it’s economically efficient in a static world. Moreover, it’s politically salable, which certainly doesn’t hurt.

But the bias favoring perfect competition is a costly one. Perfect competition is arguably psychologically unhealthy. Every benefit social, not individual. But people who are actually involved in a given business or market may have a different view—it turns out that many people actually want to be able to make a profit. The deeper criticism of perfect competition, though, is that it is irrelevant in a dynamic world. If there is no equilibrium—if things are constantly moving around—you can capture some of the value you create. Under perfect competition, you can’t. Perfect competition thus preempts the question of value; you get to compete hard, but you can never gain anything for all your struggle. Perversely, the more intense the competition, the less likely you’ll be able to capture any value at all. 

Thinking through this suggests that competition is overrated. Competition may be a thing that we’re taught, and that we do, unquestioningly. Maybe you compete in high school. Then more, tougher competition in college and grad school. And then the “rat race” in the real world. An apt, though hardly unique example of intense professional competition is the Big Law model for young lawyers from top law schools. You graduate from, say, Stanford Law and then go work at a big firm that pays you really well. You work insanely hard to try and make partner until you either do or you don’t. The odds aren’t in your favor, and you’ll probably quit before you get the chance to fail. Startup life can be tough, but also less pointlessly competitive. Of course, some people like the competitiveness of law firms. But it’s probably safe to say that most don’t. Ask anyone from the latter camp and they may well say that they never want to compete at anything again. Clearly, winning by a large margin is better than ruthless competition, if you can swing it.

Globalization seems to have a very competitive feel to it. It’s like a track and field sprint event where one runner is winning by just a few seconds, with others on his heels. That’s great and exciting if you’re the spectator. But it’s not a natural metaphor for real progress.  

If globalization had to have a tagline, it might be that “the world is flat.” We hear that from time to time, and indeed, globalization starts from that idea. Technology, by contrast, starts from the idea that the world is Mount Everest. If the world is truly flat, it’s just crazed competition. The connotations are negative and you can frame it as a race to the bottom; you should take a pay cut because people in China are getting paid less than you. But what if the world isn’t just crazed competition? What if much of the world is unique? In high school, we tend to have high hopes and ambitions. Too often, college beats them out of us. People are told that they’re small fish in a big ocean. Refusal to recognize that is a sign of immaturity. Accepting the truth about your world—that it is big and you are just a speck in it—is seen as wise.

That can’t be psychologically healthy. It’s certainly not motivating. Maybe making the world a smaller place is exactly what you want to do. Maybe you don’t want to work in big markets. Maybe it’s much better to find or make a small market, excel, and own it. And yet, the single business idea that you hear most often is: the bigger the market, the better. That is utterly, totally wrong. The restaurant business is a huge market. It is also not a very good way to make money.

The problem is that when the ocean is really big, it’s hard to know exactly what’s out there. There might be monsters or predators in some parts who you don’t want to run into. You want to steer clear of the parts painted red by all the carnage. But you can’t do that if the ocean is too big to get a handle on. Of course, it is possible to be the best in your class even if your class is big. After all,someone has to be the best. It’s just that the bigger the class, the harder it is to be number one. Well-defined, well-understood markets are simply harder to master. Hence the importance of the second clause in the question that we should keep revisiting: what valuable company are other people not building?

F. On VC, Networks, and Closing Thoughts

 Where does venture capital fit in? VCs tend not to have a very large pool of business. Rather, they rely on very discreet networks of people that they’ve become affiliated with. That is, they have access to a unique network of entrepreneurs; the network is the core value proposition, and is driven by relationships. So VC is anti-commoditized; it is personal, and often idiosyncratic. It thus has a lot in common with great businesses. The PayPal network, as it’s been called, is a set of friendships built over the course of a decade. It has become a sort of franchise. But this isn’t unique; that kind of dynamic arguably characterizes all great tech companies, i.e. last mover monopolies. Last movers build non-commoditized businesses. They are relationship-driven. They create value. They last. And they make money.

Entrepreneurship Advice

This advice is from my favourite entrepreneurship professors, including Andy Rachleff, Mark Leslie, Irv Grousbeck, Joel Peterson, Eric Schmidt, and many others.

  • Successful people listen. You have two ears and one mouth. Use them in that ratio. You learn more when you listen than when you talk.
  • Pareto principle: Always look for the 80/20. 80 percent of the value is delivered by 20 percent of the product/service. Focus on that 20 percent.
  • The importance of passion. When Warren Buffet finds people to run his business, his key criteria is to find somebody who would do the job whether they would get paid or not.
  • Be likable. People who are liked have the wind at their backs. So be liked.
  • Just when you think you’ve got it 100% right, you can be taken down.
  • People who are lucky make their own luck. And you only make your own luck by staying in the game.
  • Put on “the cloak” of leadership. A large part of your role is to inspire and motivate your employees, and people will look to you for confidence. If you were on a plane with engine problems, you don’t want the pilot to say “I am exploring a number of options and hope that…”, you want him to say, “I will do whatever it takes to land this plane.”
  • The outcome of a negotiation is largely a function of your alternatives.Know your next best option.
  • You will only be as good as the people you will recruit. Media & culture celebrate individuals, but teams succeed.
  • The best scientists can explain complex issues in simple terms. Pretty good scientists can explain complex issues in complex terms.
  • A’s hire A’s. B’s hire C’s. Always strive to hire people better than you are.
  • Be a clear, fair manager. For example, when speaking to a business unit leader that isn’t succeeding, say: “I want a strategy to win in 1-page and the objectives we need to hit each quarter to reach them.”
  • When considering a business opportunity, look for change. What inflection point are you taking advantage of? Without change, there is rarely opportunity.
  • When in doubt, just keep selling. Not a bad default strategy to communicate to your team.
  • Be humble. The markets are brutal to those who are arrogant.
  • Understand what you don’t do well. Surround yourself with people and resources that can do these things well.
  • Practice self-discipline. Set targets, have timetables, have clear unambiguous goals. Life passes quickly – days, weeks, months, years, a lifetime. “Regret for the things we did, can be tempered by time. It is regret for the things that we did not do that is inconsolable.”
  • Be yourself. In group settings, you usually serve the group best by thoughtfully expressing exactly what you are thinking. Not necessarily what the group wants to hear.
  • Learn to relax. Often overachievers are passionate about many things. Yet  it’s important to learn not to always care so much. Try being indifferent to things that aren’t that important.
  • You’ve got to give trust to get trust. Treat people as you would want to be treated. Sometimes people take advantage of you. That’s fine, don’t do business with them again.
  • Shoot for the moon.To be successful, don’t follow the pack. If you want to win, don’t hedge.

And, here is some good final advice (from Joel Peterson): 

“Appreciate the people you work with, take care of your investors, celebrate successes along the way, communicate lavishly – good news and bad news, tell the truth, don’t try to maximize everything, and stop to smell the roses. Life is pretty short and most of what really matters doesn’t happen at the office.”

CS183: Startup—Notes Essay—Party Like It’s 1999?

Thanks to blakmaster from now on every Monday I will be sharing with you Peter Thiel’s Startup Classes he is teaching in the US.

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I.  Late to the Party

History is driven by each generation’s experience. We are all born into a particular culture at a particular time. That culture is like an extended dinner conversation; lots of people are talking, some lightly, some angrily, some loudly, some in whispers. As soon as you’re able, you listen in. You try to figure out what that conversation is about. Why are people happy? Why are they upset? Sometimes it’s hard to figure out.

Take someone born in the late 1960s, for instance. There was a lot going on then, culturally. But a toddler in the late ‘60s, despite having technically lived through them, essentially missed the debates on civil rights, Vietnam, and what the U.S. was supposed to look like. The child, being more or less excluded from the dinner table, would later find it hard to get a sense of what those discussions were like.

There is a keen analogue between the cultural intensity of the ‘60s and the technological intensity of the 1990s. But today’s college and perhaps even graduate students, like the toddler in 1969, may have been too young to have viscerally experienced what was going on back in 1999. To participate in the dinner table conversation—to be able to think and talk about businesses and startups today in 2012—we must get a handle on the history of the ‘90s. It is questionable whether one can really understand startups without, say, knowing about Webvan or recognizing the Pets.com mascot.

History is a strange thing in that it often turns out to be quite different than what people who lived through it thought it was. Even technology entrepreneurs of the ‘90s might have trouble piecing together that decade’s events. And even if we look back at what actually happened, it’s not easy to know why things happened as they did. All that’s clear is that the ‘90s powerfully shaped the current landscape. So it’s important to get as good a grasp on them as possible.

 

II. A Quick History of the 90s

Most of the 1990s was not the dot com bubble. Really, what might be called the mania started in September 1998 and lasted just 18 months. The rest of the decade was a messier, somewhat chaotic picture.

The 1990s could be said to have started in November of ’89. The Berlin Wall came down. 2 months of pretty big euphoria followed. But it didn’t last long. By early 1990, the U.S. found itself in a recession—the first one in post WWII history that was long and drawn out. Though it wasn’t a terribly deep recession—it technically ended in March of ’91—recovery was relatively slow. Manufacturing never fully rebounded. And even the shift to the service economy was protracted.

So from 1992 through the end of 1994, it still felt like the U.S. was mired in recession. Culturally, Nirvana, grunge, and heroin reflected increasingly acute senses of hopelessness and lack of faith in progress. Worry about NAFTA and U.S. competitiveness vis-à-vis China and Mexico became near ubiquitous. The strong pessimistic undercurrent fueled Ross Perot’s relatively successful third party presidential candidacy. George H.W. Bush became the only 1-term President in the last thirty years. Things didn’t seem to be going right at all.

To be sure, technological development was going on in Silicon Valley. But it wasn’t that prominent. Unlike today, the Stanford campus in the late 1980s felt quite disconnected with whatever tech was happening in the valley. At that time, Japan seemed to be winning the war on the semiconductor. The Internet had yet to take off. Focusing on tech was idiosyncratic. The industry felt small.

The Internet would change all that. Netscape, with its server-client model, is probably the company most responsible for starting the Internet. It was not the first group to think of a 2-way communications network between all computers; that honor goes to Xanadu, who developed that model in 1963. Xanadu’s problem was that you needed everyone to adopt it at once for the network to work. They didn’t, so it didn’t. But it became a strange cult-like entity; despite never making any money, it kept attracting venture funding for something like 29 years, finally dying in 1992 when investors became irreversibly jaded. 

So Netscape comes along in ’93 and things start to take off. It was Netscape’s IPO in August of 1995—over halfway through the decade!—that really made the larger public aware of the Internet. It was an unusual IPO because Netscape wasn’t profitable at the time. They priced it at $14/share. Then they doubled it. On the first day of trading the share price doubled again. Within 5 months, Netscape stock was trading at $160/share—completely unprecedented growth for a non-profitable company.

The Netscape arc was reminiscent of Greek tragedy: a visionary founder, great vision, hubris, and an epic fall. An instance of Netscape’s hubris had them traveling to the Redmond campus, triumphantly plastering Netscape posters everywhere. They poked the dragon in the eye; Bill Gates promptly ordered everyone at Microsoft to drop what they were doing and start working on the Internet. IE came out shortly after that and Netscape began rapidly losing market share. Netscape’s saving grace was its legally valuable antitrust claims—probably the only reason that a company that never really made money was able to sell to AOL for over a billion dollars. 

The first three years after Netscape’s IPO were relatively quiet; by late 1998, the NASDAQ was at about 1400—just 400 points higher than it was in August ’95. Yahoo went public in ’96 at a $350M valuation, and Amazon followed in ’97 at a $460M valuation. Skepticism abounded. People kept looking at earnings and revenues multiples and saying that these companies couldn’t be that valuable, that they could never succeed.

This pessimism was probably appropriate, but misplaced. Things weren’t going particularly well in the rest of the world. Alan Greenspan delivered his famous irrational exuberance speech in 1996—a full 3 years before the bubble actually hit and things got really crazy. But even if there was irrational exuberance in 1996, the U.S. was hardly in a position to do anything about it. 1997 saw the eruption of the East Asian financial crises in which some combination of crony capitalism and massive debt brought  the Thai, Indonesian, South Korean, and Taiwanese  (to name just a few) economies to their knees.  China managed to avoid the brunt of the damage with tight capital controls. But then in 1998, the Ruble crisis hit Russia. These were unique animals in that usually, either banks go bust or your currency goes worthless. Here, we saw both. So your money was worthless, and the banks had none of it. Zero times zero is zero.

On the heels of the Russian crisis came the Long-Term Capital Management crisis; LTCM traded with enormous leverage (“picking up nickels in front of a bulldozer”), ultimately blew up, and but for a multibillion dollar bailout from the Fed, seemed poised to take down the entire U.S. economy with it. Things in Europe weren’t all that much better. The Euro launched in January 1999, but optimism about it was the exception, strong skepticism the norm. It proceeded to lose value immediately.

One way to think about the tech mania from March 1998 to September 2000, then, comes from this insight that pretty much everything else was going insanely wrong before that time. The technology bubble was an indirect proof; the old economy was proven not to work, as we could no longer compete with Mexico or China. Emerging markets were proven failures, rife with cronyism and mismanagement. Europe offered little hope. And no one wanted to invest with leverage after the LTCM disaster. So, by the late ‘90s, a process of elimination left only one good place to put money: in tech.

Of course, proof by contradiction is a dangerous way to draw conclusions. The world is not always a logical place. So even if something’s not A, B, C, or D, it doesn’t necessarily follow that the truth is E; the set may not be as simple as A thru E. But while that’s important to flag, indirect proof seems to have some purchase here. There’s still a sense in which tech worked, or was seen as working, because nothing else did, or was.

 

III.  The Mania:  September 1998 – March 2000

A. Mania Generally

The Mania started in September of ’98. Probably the best way to convey just how crazy things got is to tell people crazy stories about how crazy things got. Any tech entrepreneur from that time necessarily has scores of pretty insane anecdotes to tell. Certain common themes will run through them all: the times were extremely social. People were irrationally exuberant. It felt like there was money everywhere… probably because there was. And there was no shortage of very sketchy people running around the valley.

Admittedly, these themes reflect fairly superficial impressions. But we shouldn’t quickly dismiss them for that; quite often, the surface of things is actually the heart of things. So anecdotes that reflect the short-lived bubble zeitgeist, in addition to being kind of bizarre and fun, are worth thinking about.

And, again, there’s no shortage of anecdotes. There were 40-year-old grad students at Stanford who were trying to start dozens of rather wacky companies. Now, usually being a forty-something graduate student means you’ve gone insane. And usually, trying to start several companies at once is seen as unwise. But in late 1998, many people believed that to be a winning combination.

There were brunches at Bucks and dinners at Il Fornaio. There were billionaires from Idaho flying in giving money to anyone with an idea and a polished pitch. Fairly broke entrepreneurs racked up thousand dollar dinner bills and tried to pay in shares of their companies. Sometimes that even worked. It’s easy to look back and see a lot of ridiculousness. But it wasn’t all fluff; a great deal of activity happened in these social contexts. Launch parties became so important that someone put together an exclusive e-mail list that published rankings of the various parties going on that day.

People began to say and do pretty crazy things. Many business models adopted some weird dynamic where the more you sold or did, the more money you’d lose. It was like an SNL skit; a customer deposits $100 in pennies at the bank, and the bank loses money because it costs them more to sort through everything than that deposit is worth. But while a bank would recognize that and stop, the dot coms would say, without irony, “It’s okay… we’ll make it up in volume.” Irrationality was rational when simply adding “.com” after your name more or less doubled your value overnight. 

Yahoo grew to replace Netscape as the most hubristic tech company. By ‘97 it was largest Internet company in Silicon Valley. Yahoo encouraged PayPal in 2000 to think carefully about who to sell the company to, because you needed to know that the buyer was sound in a stock-for-stock sale. Yahoo thought itself an attractive buyer because it would pay out in Yahoo stock, which, according to Yahoo at the time, “always goes up.”

Great fortunes made in those 18 months. Plenty were lost. In 1997, Larry Augustin was deciding whether to close up VA Linux. He chose not to. In 1999, VA Linux went public at $30/share. It quickly traded up to $300, earning it the distinction of being the stock that went up more than any other on the first day of trading, ever. Since Augistin owned 10% of the company, he was worth about a billion dollars by the end of the day. People were saying that sometimes, lightning does strike twice; Augustin had previously declined an offer to be the third employee at Yahoo, which, of course, would have made him billions as well. But the VA Linux story took a turn for the worse; 6 month later, by the end of the lock-up period, the stock lost 90% of value. Anyone who didn’t sell took another 90% hit over the following 6 months. Augustin ended up with 5 or 6 million dollars, which is still a lot of money. But it’s not a billion.

All the parties, money, and IPO success stories made for lots of sketchy businesses. Those businesses were funded by sketchy VCs and run by sketchy entrepreneur-salespeople. Since everybody was running around saying pretty crazy things, it became increasingly hard to tell who was too sketchy and who wasn’t. To avoid being drawn in by slick salesmen, Max Levchin developed what he called the aura test: you listen to someone for 15 seconds and then decide if he has a good aura. If so, you continue to listen. If not, you walk away. It’s not hard to imagine that companies who employed some version of the aura test were more likely to survive the mania than those who didn’t.

B.  PayPal Mania

Since PayPal only got started in December of ’98—fairly late in the tech boom—one problem it faced was the high likelihood of hiring the sort of sketchy people that seemed to be proliferating. The founders agreed that PayPal could not afford to hire sketchy people. So they just hired their friends instead. 

PayPal’s original idea involved beaming money to people over Palm Pilots. It was voted one of the worst 10 business ideas of 1999, which is saying a lot. The initial business model was hardly better; there was a sense in which PayPal had to raise money so it could raise more money so it could then figure out what to do with all that money. And, oddly enough, it was possible to raise an angel round on that model; one archetypical angel investor, during a pitch over Chinese food at Town & Country in Palo Alto, was utterly unconcerned with what PayPal did. Rather, he wanted to know one thing: who else was investing. Later, he consulted the fortune cookie. It told him to invest.

Among the first big breaks was landing a $4.5M investment from Nokia ventures. The problem, though, was that mobile Internet didn’t quite work yet. Good interfaces were years away, and integration with handsets seemed to take forever. Much to Nokia’s surprise, PayPal announced a pivot at the first post-investment board meeting. The new idea was simple: an account-based system where you could send money to anyone with an e-mail address. It was a good idea, but it seemed too easy. Surely, serious competition had to be working on that, too. So 1999 became increasingly frantic, since people knew they had to move quickly or fail.

PayPal’s big challenge was to get new customers. They tried advertising. It was too expensive. They tried BD deals with big banks. Bureaucratic hilarity ensued. The turning point was when Luke Nosek got a meeting with the chairman and top brass at HSBC in London. Several old school bankers crowded into a large wood paneled conference room. They had no idea what to make of these California startup guys talking about the Internet. They looked so dazed and confused that they very well could have been extras who knew nothing about payments and tech at all. Luke, despite being on a life-extension calorie restriction diet, found aHäagen-Dazs. And over ice cream, the PayPal team reached an important conclusion: BD didn’t work. They needed organic, viral growth. They needed to give people money.

So that’s what they did. New customers got $10 for signing up, and existing ones got $10 for referrals. Growth went exponential, and PayPal wound up paying $20 for each new customer. It felt like things were working and not working at the same time; 7 to 10% daily growth and 100 million users was good. No revenues and an exponentially growing cost structure were not. Things felt a little unstable. PayPal needed buzz so it could raise more capital and continue on. (Ultimately, this worked out. That does not mean it’s the best way to run a company. Indeed, it probably isn’t.)

 Feb 16, 2000 was a good day for PayPal; the Wall Street Journal ran a flattering piece that covered the company’s exponential growth and gave it a very back of the envelope valuation of $500M. The next month, when PayPal raised another round of funding, the lead investor accepted the WSJ’s Feb. 16 valuation as authoritative.

That March was thoroughly crazy. A South Korean firm that really wanted to invest called up PayPal’s law firm to ask where they could wire funds to invest. It promptly wired $5M without signing any documents or negotiating a deal. The Koreans absolutely refused to say where PayPal could send the money back. The attitude was simple: “No. You have to take it.” PayPal closed its $100M round on March 31st. The timing was fortunate, since after that everything sort of crashed. PayPal was left with the challenge of building a real business. 

The transition from 1999 to 2000 was much like Prince predicted it would be in his song “1999” (“Cause they say 2,000 zero zero party over, oops! Out of time!So tonight I’m gonna party like it’s 1999!”). Perhaps he was right for the wrong reasons; we shouldn’t make too much of that. But it turned out quite prescient. A rolling wave of collapse struck; marketing-driven e-commerce companies failed in the first half of 2000, and B2B companies failed in the second. The telecoms followed in 2001. If you had to pick what sector of economy was at absolute lowest in March 2000, it might have been be military defense companies. The NASDAQ was soaring. No one believed there would ever be another war. But then things reversed. The military defense industry would rise for most of the next decade.

 

IV.  Hubris and Schadenfreude

In the aftermath of 2001 and 2002, enormous amounts of hubris yielded to Shadenfreude. People insisted that “we were right all along,” and became culturally and socially depressed.

PayPal would survive this shift, but it was clear that it was a whole new world. The company broke even in 2001. It was able to solve some tough fraud problems and get a handle on its customer service problems. When it filed for IPO in late September 2001, PayPal became the first company to file after 9/11. This time, some 20 months after the rosy WSJ article, another article came out. It was titled “Earth To Palo Alto.” It began:

What would you do with a 3-year-old company that has never turned an annual profit, is on track to lose a quarter billion dollars and whose recent SEC filings warn that its services might be used for money laundering and financial fraud?

If you were the managers and venture capitalists behind Palo Alto’s PayPal, you’d take it public. And that is what they hope to do in an $80 million offering that will test the limits of investor tolerance and financial market gullibility.

It didn’t get much better. The U.S., it concluded, “needs [PayPal] as much as it does an anthrax epidemic.”

 

V.  Lessons Learned

 A.  By The World

The key takeaway for most people was that the tech explosion of the late ‘90s was all a bubble. A shift back to the real economy was needed. If the expression in the ‘90s was “bricks to clicks,” the 2000s demanded a return from clicks back to bricks. People got into housing and emerging markets. High profile investors like Warren Buffet avoided tech stocks in favor of old economy ones. Profit alone mattered in evaluating businesses. Globalization was favored over technology. The general sense was that the dot com crash taught us that the future was fundamentally indeterminate. That all prophets are false prophets. That we shouldn’t believe anything people tell us, ever.

The only problem with those lessons is that they’re probably all wrong. At their core are complex, reactionary emotions; they’re driven by hubris, envy, and resentment against the ‘90s generally. When base emotions are driving, analysis becomes untrustworthy.

The reality is that people were right about lots of things in the ‘90s. The indirect proof that judged tech to be king was not weakened by the excesses that would come. There was a problem with the Euro. There were problems with war, crony capitalism, and overleverage. Tech did not work perfectly, and insofar as it didn’t protective reactions against the bubble may be justified. But March of 2000 wasn’t just a peak of insanity. In some important ways, it was still a peak of clarity as well.

B.  By Silicon Valley

People in Silicon Valley learned that you have to do things differently to survive in the Schadenfreude world. First, you had to believe and practice incrementalism. Grand visions and moving quickly fell out of favor. 

Second, your startup had to be “lean.” You should not, in fact, know what you’re going to do. Instead, you should experiment, iterate, and figure it out as time goes on.

Third, you should have zero advertising spend. If your growth isn’t viral, it’s fake. 

Fourth, anti-social was the new social. People wanted to withdraw into a new antisocial modality. Google is the iconic cultural version of this; a product for people who’d rather interact with computers than people.

Fifth, product needed elevation over business development. In 1999, smart non-engineers were doing BD. In 2001, they were doing product. In the ‘90s, iconic CEOs were salespeople. E.g. Larry Ellison. In the 2000s, iconic CEOs were product visionaries. E.g. Steve Jobs.

Sixth, rapid monetization was to be distrusted. Better is a more protracted growth phase and later IPO. If you have company that’s growing relatively quickly, you should probably reinvest profits and make it grow even more quickly.

Finally—and this was the overarching theme—you shouldn’t discuss the future. That will just make you look weird and crazy, and, well, you just shouldn’t do it.

Overall, the post-mania was one big strategic retreat that incorporated all of these elements. Which elements are right and which are wrong a is complicated question. But it’s a question worth asking. Certainly there were good reasons for the retreat. But in many aspects it was probably overblown. Some elements make sense; why IPO early in an environment that, all of a sudden, is hostile to high-growth tech stocks? But others are questionable, at least as ironclad rules; should you never advertise? Never do BD/sales? Are you sure we can’t talk about the future? We should be open to idea that some or much of the retreat—however necessary it was generally—was overreaction.

 

VI.  Bubbles

The big legacy question from the ‘90s is: are we in a tech bubble?  

Many people say yes. The Richter Scales’ “Here Comes Another Bubble Video” below, done in October 2007, is strikingly undated in how people are thinking about things today.

Now we’re back to the dinner conversation that people are stuck in. There are lots of good questions to ask about the conversation. But the question of bubble vs. no bubble is not one of them. Indeed, that’s the wrong question at this point. Sure, one can string together some random data points that suggest things are frothy.  More people may be doing CS at Stanford now than back in ’99. Valuations may be creeping up.

But some data points on some froth hardly shows that the bubble thesis is accurate. And the weight of the evidence suggests it’s inaccurate. Bubbles arise when there is (1) widespread, intense belief that’s (2) not true. But people don’t really believe in anything in our society anymore. You can’t have a bubble absent widespread, intense belief. The incredible narrative about a tech bubble comes from people who are looking for a bubble. That’s more overreaction to the pain of the ‘90s than it is good analysis.

Antibubble type thinking is probably somewhat more true. In other words, it’s probably better to insist that everything is going to work and that people should buy houses and tech stocks than it is to claim that there’s a bubble. But we should resist that, too. For bubble and anti-bubble thinking are both wrong because they hold the truth is social. But if the herd isn’t thinking at all, being contrarian—doing the opposite of the herd—is just as random and useless.

To understand businesses and startups in 2012, you have to do the trulycontrarian thing: you have to think for yourself. The question of what is valuable is a much better question than debating bubble or no bubble. The value question gets better as it gets more specific: is company X valuable? Why? How should we figure that out? Those are the questions we need to ask. Next class, we’ll look at how we might go about thinking about them.

 

 

 

Peter Thiel’s CS183: Startup – Class 1 Notes Essay

Thanks to blakmaster from now on every Monday I will be sharing with you Peter Thiel’s Startup Classes he is teaching in the US.

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Peter Thiel’s CS183: Startup – Class 1 Notes Essay

Here is an essay version of one of Peter Thiel’s students notes from Class 1 of CS183: Startup. Errors and omissions are my own. Credit for good stuff is Peter’s entirely.

CS183: Startup—Notes Essay—The Challenge of the Future

Purpose and Preamble

       We might describe our world as having retail sanity, but wholesale madness. Details are   well        understood; the big picture remains unclear. A fundamental challenge—in business as in life—is to integrate the micro and macro such that all things make sense.

            Humanities majors may well learn a great deal about the world. But they don’t really learn career skills through their studies. Engineering majors, conversely, learn in great technical detail. But they might not learn why, how, or where they should apply their skills in the workforce. The best students, workers, and thinkers will integrate these questions into a cohesive narrative. This course aims to facilitate that process.

I.          The History of Technology

For most of recent human history—from the invention of the steam engine in the late 17th century through about the late 1960’s or so— technological process has been tremendous, perhaps even relentless. In most prior human societies, people made money by taking it from others. The industrial revolution wrought a paradigm shift in which people make money through trade, not plunder.

The importance of this shift is hard to overstate. Perhaps 100 billion people have ever lived on earth. Most of them lived in essentially stagnant societies; success involved claiming value, not creating it. So the massive technological acceleration of the past few hundred years is truly incredible.

The zenith of optimism about the future of technology might have been the 1960’s. People believed in the future. They thought about the future. Many were supremely confident that the next 50 years would be a half-century of unprecedented technological progress.

But with the exception of the computer industry, it wasn’t. Per capita incomes are still rising, but that rate is starkly decelerating. Median wages have been stagnant since 1973. People find themselves in an alarming Alice-in-Wonderland-style scenario in which they must run harder and harder—that is, work longer hours—just to stay in the same place. This deceleration is complex, and wage data alone don’t explain it. But they do support the general sense that the rapid progress of the last 200 years is slowing all too quickly.

II.         The Case For Computer Science

Computers have been the happy exception to recent tech deceleration. Moore’s/Kryder’s/Wirth’s laws have largely held up, and forecast continued growth. Computer tech, with ever-improving hardware and agile development, is something of a model for other industries. It’s obviously central to the Silicon Valley ecosystem and a key driver of modern technological change. So CS is the logical starting place to recapture the reins of progress.

III.       The Future For Progress

A.        Globalization and Tech: Horizontal vs. Vertical Progress

Progress comes in two flavors: horizontal/extensive and vertical/intensive. Horizontal or extensive progress basically means copying things that work. In one word, it means simply “globalization.” Consider what China will be like in 50 years. The safe bet is it will be a lot like the United States is now. Cities will be copied, cars will be copied, and rail systems will be copied. Maybe some steps will be skipped. But it’s copying all the same.

Vertical or intensive progress, by contrast, means doing new things. The single word for this is “technology.” Intensive progress involves going from 0 to 1 (not simply the 1 to n of globalization). We see much of our vertical progress come from places like California, and specifically Silicon Valley. But there is every reason to question whether we have enough of it. Indeed, most people seem to focus almost entirely on globalization instead of technology; speaking of “developed” versus “developing nations” is implicitly bearish about technology because it implies some convergence to the “developed” status quo. As a society, we seem to believe in a sort of technological end of history, almost by default.

It’s worth noting that globalization and technology do have some interplay; we shouldn’t falsely dichotomize them. Consider resource constraints as a 1 to n subproblem. Maybe not everyone can have a car because that would be environmentally catastrophic. If 1 to n is so blocked, only 0 to 1 solutions can help. Technological development is thus crucially important, even if all we really care about is globalization.

B.         The Problems of 0 to 1

Maybe we focus so much on going from 1 to because that’s easier to do. There’s little doubt that going from 0 to 1 is qualitatively different, and almost always harder, than copying something times. And even trying to achieve vertical, 0 to 1 progress presents the challenge of exceptionalism; any founder or inventor doing something new must wonder: am I sane? Or am I crazy?

Consider an analogy to politics. The United States is often thought of as an “exceptional” country. At least many Americans believe that it is. So is the U.S. sane? Or is it crazy? Everyone owns guns. No one believes in climate change. And most people weigh 600 pounds. Of course, exceptionalism may cut the other way. America is the land of opportunity. It is the frontier country. It offers new starts, meritocratic promises of riches. Regardless of which version you buy, people must grapple with the problem of exceptionalism. Some 20,000 people, believing themselves uniquely gifted, move to Los Angeles every year to become famous actors. Very few of them, of course, actually become famous actors. The startup world is probably less plagued by the challenge of exceptionalism than Hollywood is. But it probably isn’t immune to it.

C.        The Educational and Narrative Challenge

Teaching vertical progress or innovation is almost a contradiction in terms. Education is fundamentally about going from 1 to n. We observe, imitate, and repeat. Infants do not invent new languages; they learn existing ones. From early on, we learn by copying what has worked before.

That is insufficient for startups. Crossing T’s and dotting I’s will get you maybe 30% of the way there. (It’s certainly necessary to get incorporation right, for instance. And one can learn how to pitch VCs.) But at some point you have to go from 0 to 1—you have to do something important and do it right—and that can’t be taught. Channeling Tolstoy’s intro to Anna Karenina, all successful companies are different; they figured out the 0 to 1 problem in different ways. But all failed companies are the same; they botched the 0 to 1 problem.

So case studies about successful businesses are of limited utility. PayPal and Facebook worked. But it’s hard to know what was necessarily path-dependent. The next great company may not be an e-payments or social network company. We mustn’t make too much of any single narrative. Thus the business school case method is more mythical than helpful.

D.        Determinism vs. Indeterminism

Among the toughest questions about progress is the question of how we should assess a venture’s probability of success. In the 1 to n paradigm, it’s a statistical question. You can analyze and predict. But in the 0 to 1 paradigm, it’s not a statistical question; the standard deviation with a sample size of 1 is infinite. There can be no statistical analysis; statistically, we’re in the dark.

We tend to think very statistically about the future. And statistics tells us that it’s random. We can’t predict the future; we can only think probabilistically. If the market follows a random walk, there’s no sense trying to out-calculate it.

But there’s an alternative math metaphor we might use: calculus. The calculus metaphor asks whether and how we can figure out exactly what’s going to happen. Take NASA and the Apollo missions, for instance. You have to figure out where the moon is going to be, exactly. You have to plan whether a rocket has enough fuel to reach it. And so on. The point is that no one would want to ride in a statistically, probabilistically-informed spaceship.

Startups are like the space program in this sense. Going from 0 to 1 always has to favor determinism over indeterminism. But there is a practical problem with this. We have a word for people who claim to know the future: prophets. And in our society, all prophets are false prophets. Steve Jobs finessed his way about the line between determinism and indeterminism; people sensed he was a visionary, but he didn’t go too far. He probably cut it as close as possible (and succeeded accordingly).

The luck versus skill question is also important. Distinguishing these factors is difficult or impossible. Trying to do so invites ample opportunity for fallacious reasoning. Perhaps the best we can do for now is to flag the question, and suggest that it’s one that entrepreneurs or would-be entrepreneurs should have some handle on.

E.         The Future of Intensive Growth

There are four theories about the future of intensive progress. First is convergence; starting with the industrial revolution, we saw a quick rise in progress, but technology will decelerate and growth will become asymptotic.

Second, there is the cyclical theory. Technological progress moves in cycles; advances are made, retrenchments ensue. Repeat. This has probably been true for most of human history in the past. But it’s hard to imagine it remaining true; to think that we could somehow lose all the information and know-how we’ve amassed and be doomed to have to re-discover it strains credulity.

Third is collapse/destruction. Some technological advance will do us in.

Fourth is the singularity where technological development yields some AI or intellectual event horizon.

People tend to overestimate the likelihood or explanatory power of the convergence and cyclical theories. Accordingly, they probably underestimate the destruction and singularity theories.

IV.       Why Companies?

If we want technological development, why look to companies to do it? It’s possible, after all, to imagine a society in which everyone works for the government. Or, conversely, one in which everyone is an independent contractor. Why have some intermediate version consisting of at least two people but less than everyone on the planet?

The answer is straightforward application of the Coase Theorem. Companies exist because they optimally address internal and external coordination costs. In general, as an entity grows, so do its internal coordination costs. But its external coordination costs fall. Totalitarian government is entity writ large; external coordination is easy, since those costs are zero. But internal coordination, as Hayek and the Austrians showed, is hard and costly; central planning doesn’t work.

The flipside is that internal coordination costs for independent contractors are zero, but external coordination costs (uniquely contracting with absolutely everybody one deals with) are very high, possibly paralyzingly so. Optimality—firm size—is a matter of finding the right combination.

V.        Why Startups?

A.        Costs Matter

Size and internal vs. external coordination costs matter a lot. North of 100 people in a company, employees don’t all know each other. Politics become important. Incentives change. Signaling that work is being done may become more important than actually doing work. These costs are almost always underestimated. Yet they are so prevalent that professional investors should and do seriously reconsider before investing in companies that have more than one office. Severe coordination problems may stem from something as seemingly trivial or innocuous as a company having a multi-floor office. Hiring consultants and trying to outsource key development projects are, for similar reasons, serious red flags. While there’s surely been some lessening of these coordination costs in the last 40 years—and that explains the shift to somewhat smaller companies—the tendency is still to underestimate them. Since they remain fairly high, they’re worth thinking hard about.

Path’s limiting its users to 150 “friends” is illustrative of this point. And ancient tribes apparently had a natural size limit that didn’t much exceed that number. Startups are important because they are small; if the size and complexity of a business is something like the square of the number of people in it, then startups are in a unique position to lower interpersonal or internal costs and thus to get stuff done.

The familiar Austrian critique dovetails here as well. Even if a computer could model all the narrowly economic problems a company faces (and, to be clear, none can), it wouldn’t be enough. To model all costs, it would have to model human irrationalities, emotions, feelings, and interactions. Computers help, but we still don’t have all the info. And if we did, we wouldn’t know what to do with it. So, in practice, we end up having companies of a certain size.

B.         Why Do a Startup?

The easiest answer to “why startups?” is negative: because you can’t develop new technology in existing entities. There’s something wrong with big companies, governments, and non-profits. Perhaps they can’t recognize financial needs; the federal government, hamstrung by its own bureaucracy, obviously overcompensates some while grossly undercompensating others in its employ. Or maybe these entities can’t handle personal needs; you can’t always get recognition, respect, or fame from a huge bureaucracy. Anyone on a mission tends to want to go from 0 to 1. You can only do that if you’re surrounded by others to want to go from 0 to 1. That happens in startups, not huge companies or government.

Doing startups for the money is not a great idea. Research shows that people get happier as they make more and more money, but only up to about $70,000 per year. After that, marginal improvements brought by higher income are more or less offset by other factors (stress, more hours, etc. Plus there is obviously diminishing marginal utility of money even absent offsetting factors).

Perhaps doing startups to be remembered or become famous is a better motive. Perhaps not. Whether being famous or infamous should be as important as most people seem to think it is highly questionable. A better motive still would be a desire to change the world. The U.S. in 1776-79 was a startup of sorts. What were the Founders motivations? There is a large cultural component to the motivation question, too. In Japan, entrepreneurs are seen as reckless risk-takers. The respectable thing to do is become a lifelong employee somewhere. The literary version of this sentiment is “behind every fortune lies a great crime.” Were the Founding Fathers criminals? Are all founders criminals of one sort or another?

C.        The Costs of Failure

Startups pay less than bigger companies. So founding or joining one involves some financial loss. These losses are generally thought to be high. In reality, they aren’t that high.

The nonfinancial costs are actually higher. If you do a failed startup, you may not have learned anything useful. You may actually have learned how to fail again. You may become more risk-averse. You aren’t a lottery ticket, so you shouldn’t think of failure as just 1 of n times that you’re going to start a company. The stakes are a bit bigger than that.

A 0 to 1 startup involves low financial costs but low non-financial costs too. You’ll at least learn a lot and probably will be better for the effort. A 1 to n startup, though, has especially low financial costs, but higher non-financial costs. If you try to do Groupon for Madagascar and it fails, it’s not clear where exactly you are. But it’s not good.

VI.       Where to Start?

The path from 0 to 1 might start with asking and answering three questions. First, what is valuable? Second, what can I do? And third, what is nobody else doing?

The questions themselves are straightforward. Question one illustrates the difference between business and academia; in academia, the number one sin is plagiarism, not triviality. So much of the innovation is esoteric and not at all useful. No one cares about a firm’s eccentric, non-valuable output. The second question ensures that you can actually execute on a problem; if not, talk is just that. Finally, and often overlooked, is the importance of being novel. Forget that and we’re just copying.

The intellectual rephrasing of these questions is: What important truth do very few people agree with you on?

The business version is: What valuable company is nobody building?

These are tough questions. But you can test your answers; if, as so many people do, one says something like “our educational system is broken and urgently requires repair,” you know that that answer is wrong (it may be a truth, but lots of people agree with it). This may explain why we see so many education non-profits and startups. But query whether most of those are operating in technology mode or globalization mode. You know you’re on the right track when your answer takes the following form:

“Most people believe in X. But the truth is !X.”

Make no mistake; it’s a hard question. Knowing what 0 to 1 endeavor is worth pursuing is incredibly rare, unique, and tricky. But the process, if not the result, can also be richly rewarding.

Please, Startup world, drop the fluffy BS “Growth Hacker” title and focus on growing your companies!

In my opinion a Growth Hacker is simply a Marketer with a “cooler” title…

So, why is the title “Growth Hacker” a bunch of BS?

Because it’s just a way for marketing averse startups to hire marketers without having to publicly say they’re hiring marketers.

The startup world notoriously scoffs at anything to do with Marketing (just feels dirty), SEO (SPAMMERS!), or user tracking and conversion optimization (omgmyprivacy). So when these companies all of a sudden start realizing they need to actually, ya know, make some money, they also realize they need to bring in some people who specialize in growing customer bases: Marketers.

But since marketing is taboo, startuppers just came up with a new name, “Growth Hacker” and ran with that rather than just facing the fact that a Growth Hacker IS a Marketer.

The internet is a fantastic landscape for marketers. Why? Because you can track your efforts extremely quickly and extremely accurately. Gone are the days of timing a Radio ad correctly and crossing your fingers. We can now look at our usage data for our products, refine our offering and marketing message to cater well to our customer base, and then split test various ideas programmatically and let the data speak for itself. This isn’t hacking, this isn’t magic…it’s just plain ol’ Marketing at a much more advanced and accurate level.

Bottom line…

it’s not black magic nor is it hacking at all. Just because you use cohorts and automated funnel analysis and multivariate testing and referral schemes doesn’t mean you’re no longer a Marketer and all of a sudden a Growth Hacker…

You’re just a really good Marketer!